Divorce is challenging enough on its own, but when one spouse files for bankruptcy during or before the process, the situation becomes exponentially more complicated. Legal rights, asset division, and financial liabilities shift dramatically, and missteps can lead to significant financial losses. Understanding the intersection of these two legal processes is critical to protecting your interests.
Types of Bankruptcy: What You Need to Know
Under federal law, individuals typically file for one of two types of bankruptcy: Chapter 7 or Chapter 13. The choice affects how assets, debts, and the divorce itself will be handled.
Chapter 7 Bankruptcy: Liquidation
- Assets are sold to pay creditors, but exemptions exist for necessities such as a primary home (up to a certain value), personal property, and retirement accounts.
- The process usually takes four to six months, which makes it the faster option.
- If a couple files jointly, marital debts can be discharged together before the divorce, simplifying financial separation.
- However, filing after the divorce may be necessary if one spouse’s income alone makes them eligible for Chapter 7 when they wouldn’t have qualified as a couple.
See more details on Chapter 7 here.
Chapter 13 Bankruptcy: Reorganization
- Instead of liquidating assets, this involves a structured repayment plan lasting three to five years.
- Because the case remains open for years, it can greatly delay divorce finalization.
- If a couple has significant joint debts, filing before divorce may be beneficial, as it allows them to restructure obligations before separation.
- However, if one spouse files individually, they must continue making payments on joint debts, and the other spouse remains fully responsible if they default.
See more details on Chapter 13 bankruptcy here.
How Property Division Is Affected by Bankruptcy
Colorado is an equitable distribution state, meaning assets are divided fairly, but not necessarily equally. When one spouse declares bankruptcy, however, asset division becomes more complex.
- The Bankruptcy Trustee’s Role: When bankruptcy is filed, a court-appointed trustee gains control over the filer’s assets. This means marital property that would have been divided in a divorce could instead be seized and used to pay creditors.
- Jointly Owned Property: If a jointly owned asset is not fully exempt under bankruptcy law, the trustee may force its sale. This can disrupt the divorce agreement, especially if the non-filing spouse was expecting to retain certain assets.
- Separate Property Protections: Property acquired before marriage or through inheritance is typically protected—unless it was commingled with marital assets, making it fair game for creditors.
Debt Division and Bankruptcy: Who Pays What?
Debts are also divided equitably in Colorado, but bankruptcy can shift responsibility unexpectedly.
- Joint Debts: If one spouse files for bankruptcy and has joint debts (e.g., a mortgage, car loan, or credit card), creditors can pursue the non-bankrupt spouse for the full amount.
- Individual Debts: If a debt is in one spouse’s name alone and they file for bankruptcy, their obligation is discharged, but the other spouse is unaffected unless they co-signed.
- Divorce Settlements and Hold Harmless Clauses: If a divorce decree assigns a debt to one spouse and they later file for bankruptcy, the creditor may still go after the other spouse unless a hold harmless clause was included in the settlement. However, even a hold harmless clause may not prevent collection if the debt is joint.
The Automatic Stay: How Bankruptcy Can Delay Divorce
When someone files for bankruptcy, the court issues an automatic stay, which halts all collection actions, including those related to property division and debt settlements in divorce. This can cause major delays because:
- The bankruptcy court must first resolve asset distribution before a divorce court can finalize property settlements.
- Divorce courts can still rule on child support and alimony because these are considered family support obligations, which are not dischargeable in bankruptcy.
- If one spouse uses bankruptcy as a stalling tactic, the other can request relief from the automatic stay to continue divorce proceedings.
Should You File for Bankruptcy Before or After Divorce?
This decision depends on financial circumstances and strategic considerations:
- Filing before divorce may be better if:
- Both spouses have significant joint debt that they want to eliminate together.
- They qualify for Chapter 7, allowing for a quick discharge of debts.
- They want to avoid costly litigation over debt division during divorce.
- Filing after divorce may be better if:
- One spouse’s post-divorce income allows them to qualify for Chapter 7 when they wouldn’t have qualified as a couple.
- The non-filing spouse wants to protect their assets from being entangled in bankruptcy proceedings.
- The divorce decree can clarify who is responsible for which debts, reducing disputes with the bankruptcy trustee.
Navigating Divorce and Bankruptcy: Get Professional Help
If you are facing divorce and one or both parties are considering bankruptcy, legal and financial guidance is essential. The interplay between these two legal processes is complex, and making uninformed decisions can lead to financial ruin.
At Lewis & Matthews, P.C., we have extensive experience handling both divorce and bankruptcy-related legal issues. We help clients:
- Determine the best timing for filing bankruptcy relative to divorce.
- Protect assets that might otherwise be lost to creditors.
- Navigate court delays caused by automatic stays.
- Ensure equitable debt division to minimize financial burdens.
To discuss your specific situation and explore your best legal options, contact us today.
