Bankruptcy treatment of debts resulting from a divorce
It is estimated that 50% of all marriages end in divorce. Studies of what triggers bankruptcy uniformly find that the financial impact of a divorce is one of the most frequent causes, along with loss of employment or substantial medical expenses.
But unlike the types of general unsecured debts like credit cards, loans, and medical debt that rapidly accumulate when a job is lost or health issues cause piles of debt to suddenly overwhelm a family, many of the debts that result from divorce proceedings are treated quite differently in the bankruptcy process. Deciding whether to seek bankruptcy protection is always a difficult decision to be undertaken with care. When a debtor is confronted with debts that may be largely the result of a divorce, extra consideration should be taken.
While there is a general presumption that debts are dischargeable in bankruptcy, certain debts are not subject to discharge. For example, taxes recently incurred, criminal penalties and fines, and presumptively student loan debts are not dischargeable. But there are exist special rules for debts that result from divorce litigation.
It has long been the rule that obligations for payment of child support or alimony cannot be discharged in bankruptcy. But what about debts incurred that are for or “in the nature” of support? For example, a debt resulting from a promise to make payments for an estranged spouse's apartment or car? After all, promising to pay the car payment or rent of a spouse directly, rather than pay alimony to be used for those needs, serves the same purpose. For that reason, numerous cases uphold the nondischargeability of such promises that serve the equivalent function of spousal or child support.
But what about debts owing to third parties or entities that do not substitute for direct support needs. Generally, an order to pay for the legal fees of and estranged spouse because of the disparity of income have been held to also be in the nature of support. In other words, if the spouses have considerably different incomes and therefore unequal access to legal representation, an order for payment of attorney fees in order to “level the playing field” because of the income disparity has been held to be also in the nature of support. This can also include orders to pay for child custody evaluators, minors' counsel and others where the payment serves to promote the welfare and needs of the children.
Until the mid-1980s, debts not for or in the nature of support arising in divorce litigation were given no special treatment or protection. But for the past 30+ years, an additional category of nondischargeable claims arising from family law litigation have been given protection against discharge. These debts, characterized as “marital debts”, must arise from the divorce litigation or from settlement agreements reached in connection with such litigation. But they also must not be for or in the nature of support, which would already make them nondischargeable. In addition, the debts also must be payable to the estranged or former spouse. If payable to others, such as credit card companies or former in-laws, such debts are dischargeable. Like support obligations, these marital debts are non-dischargeable in case is filed under Chapters 7, 11 and 12.
But they can be discharged in a case filed under Chapter 13. Traditionally, the discharge awarded upon the completion of a Chapter 13 plan is somewhat broader than the discharge awarded in other chapters. This is an expression of the view of Congress that those who endeavor to repay all or a portion of their debts in Chapter 13 are entitled to greater relief. After all, the Chapter 13 debtor labors to make payments into a plan for a term ranging between 36 and 60 months. Thus, if the confirmed plan based upon the best efforts of the debtor pays only 50% of the general unsecured claims, the Chapter 13 discharge will nonetheless serve to discharge the unpaid remaining balance of those debts, including the marital debt.
When considering what chapter will provide the greatest relief, debtors emerging from contentious and costly family law litigation may want to consider the benefits of proceeding in Chapter 13 if the divorce has resulted in substantial marital debt. Additionally, debtors who have fallen behind in meeting their support obligations may find that Chapter 13 offers protection while formulating the plan to “catch up” with child support or alimony arrearages, which cannot be discharged, but can be paid out over time under the Chapter 13 plan. In such a situation, the debtor need only make the current support payments, while the accumulated arrearages are paid off over time through the plan.
Bankruptcy is an option for those who have encountered unforeseen calamities that have dashed expectations and undercut abilities to stay current with debts. But depending on the nature of the debts, careful consideration needs to be given to choosing the relief that is most appropriate, whether it be a Chapter 7 case or a Chapter 13 case. Such a determination should only be made after consulting with counsel qualified to advise clients concerning the interplay between bankruptcy law and family law.