Introduction

The pandemic has taken a toll on married couples both financially and emotionally, which has caused many to contemplate filing for both divorce and bankruptcy. This is not to say that every bankruptcy leads to a subsequent divorce, or that every divorce will warrant the filing of a bankruptcy.  However, this article provides an overview of which process should be initiated first for those couples in the unique situation of being on the brink of filing for both divorce and bankruptcy. There is not a cookie cutter road map directing an individual’s (or couple’s) path between these two areas of law.  Instead, each factual circumstance should be reviewed with the assistance of counsel to consider all options to aid in the difficult, and likely stressful, times impacted by these areas of law.

Overview Bankruptcy Process

Qualification for Chapter 7, 11, or, 13

There are many circumstances in which a couple may consider filing for financial relief provided under the Bankruptcy Code. In a Chapter 7 bankruptcy where non-exempt (or unprotected) assets (such as an ATV, boat, or stocks not otherwise held in a qualified retirement account) are liquidated and the couple is relieved of the obligation of the majority of their debts.  In a Chapter 11 or 13, there is a reorganization or specified term (typically 3 – 5 years) where the couple will make payments to the creditors, and upon completing these plan payments, the couple will then be relieved of the obligation of the majority of their debts.  The more common debts that the couple will no longer be responsible for (or discharged from) are credit cards, medical debts, or deficiency balances from auto loans.

Each chapter of bankruptcy comes with certain similarities, such as similar documents to be prepared that identify all of the assets and liabilities, as well as state law protections for certain real and personal property assets.  It is important to note that the Bankruptcy Code requires the disclosure of all assets and all liabilities.  Someone seeking relief under the Bankruptcy Code does not get to make the independent determination that they “are not filing bankruptcy on a particular asset…”  However, a couple does not always have the ability to “choose” which chapter of bankruptcy they would like to pursue.  There is an income analysis that must be completed to affirm which options a couple may consider.

Arizona Statutory Exemptions of Assets (Real and Personal)

If a couple has resided in Arizona for 91 days prior to filing for bankruptcy; their bankruptcy will be filed in Arizona.  Historically, the location where someone files for bankruptcy has not been a major factor, but with the continued impact of COVID-19 more families are relocating away from areas “close” to their place of employment based on the prospective ongoing ability to work from home, thus raising additional potential considerations of where a party should file bankruptcy.

For purposes of this discussion, we will presume a couple considering bankruptcy will file in the state of Arizona.  Dependent on how long the couple has resided in Arizona; it is likely they will qualify for Arizona exemptions.  Again for purposes of this discussion, we will further presume the couple has resided in Arizona and the requisite time before filing bankruptcy for Arizona statutes to apply.  Arizona statutes delineate the exemptions for which assets (or value of assets) are protected from liquidation or a bankruptcy filing.  Typically, statutory exemptions include protecting certain categories of personal property up to a certain dollar value, such as equity in one vehicle, wedding rings, clothing, electronics, pets, and furniture. In addition, Arizona statutes provide that a debtor’s homestead (or house) is protected up to $150,000 in equity.  Meaning if an individual’s home is valued in the amount of $400,000, there is a mortgage (or lien) on the real property in the amount of $250,000 – the individual’s home is not likely subject to being liquidated based on the protection provided by the Arizona statutes.

A “fresh start” is the overarching relief provided under the Bankruptcy Code.  Once the Bankruptcy Court enters the Chapter 7 Discharge, the dischargeable debts (e.g. credit cards, deficiency on vehicle loans, or guarantees of prior business loans) will no longer be the obligation or responsibility of the debtor.  Similarly, in an individual Chapter 11 or 13, once the plan payments are completed, the Bankruptcy Court will then enter a similar discharge providing the same relief.  However, not all debts are dischargeable.  The more common non-dischargeable debts fall within the following categories: student loans and tax obligations.

Overview Divorce Process

For couples contemplating divorce along with bankruptcy, it is important to understand the divorce process. In order to file for a divorce in Arizona, the couple must reside in the state of Arizona for 90 days prior to filing.  The divorce filing is prepared by only one spouse and served on the other spouse.  The date the filing is served on the other spouse is typically the date the community terminates. The community is considered as all assets and debts acquired throughout the marriage, regardless of whether such assets or debts are titled in only one spouse’s name. In a divorce, you divide the assets and debts in the community according to the value as of the community termination date.

Importantly, a Preliminary Injunction is issued and served concurrently with the divorce filing, which prohibits either party from taking unilateral action to sell or transfer assets from the community without the written permission of the other spouse or the court. In addition, both parties are prohibited from concealing community assets from the other spouse or encumbering the assets by taking out loans using the community assets as security. In other words, the Preliminary Injunction places a hold on the community for the parties to maintain the status quo while the divorce is being finalized. The Preliminary Injunction remains in place throughout the divorce proceedings until the divorce is finalized by court order.

The parties are required to exchange mandatory disclosures of all assets, debts, and financial information. The parties will also be required to prepare and file an Affidavit of Financial Information which provides an accounting of monthly income and expenses. The parties have the opportunity to discover financial information through requests made to the other spouse or third parties to confirm that all information has been disclosed. The parties can also engage an expert to appraise the value of community assets as of the community termination date, such as for homes, businesses, or even jewelry. The purpose is to untie the financial knot by equitably dividing all community assets and debts at the appropriate values.

The parties can either reach a settlement on the community division or have a trial where a judge makes the determination. The parties are officially divorced when it is memorialized in a Decree that is either approved by the court if the parties were able to reach a settlement or in a ruling if the court makes the determination. The parties will know they are officially divorced when they have the Decree, but creditors will not and may seek payment on a debt the other party was responsible for paying according to the terms of the Decree. Providing a copy of the Decree may stop debt collectors, but in some cases you may have to seek reimbursement from your former spouse. It is wise to have a “hold harmless” clause in your Decree stating that either spouse will hold the other harmless from any unpaid debts that may be pursued against the non-obligated spouse, which could lead to the non-obligated spouse being reimbursed for any amounts paid including attorneys’ fees and costs.

A divorce is unique and personal for each couple. Although this is a general overview of the divorce process, there may be variations and nuances due to personal circumstances, and it is important to consult an attorney for information and advice specific to an individual’s case.

Should One be filed Before the Other?

Regardless of filing for divorce or bankruptcy first, both processes are intensive and require an individual to engage in a thorough accounting of all assets and debts. There are many factors that an individual should consider when contemplating which process to begin first, which are dependent upon each couple or individual’s unique circumstances. However, it is important to keep in mind that when bankruptcy proceedings commence, an automatic stay is issued that places a hold on the assets, impacting the ability to divide or liquidate assets in a concurrent divorce proceeding.  Similarly, a Preliminary Injunction is issued at the beginning of a divorce proceeding that may prevent community assets from being sold or liquidated in a concurrent bankruptcy proceeding without the written permission of the other spouse. Therefore, it is generally recommended that a couple complete one proceeding before initiating the other.

Based purely on considering a couple’s assets and liabilities, a divorce either through a settlement agreement or a court ruling will determine what each individual gets to retain post-divorce, and what obligations each individual will continue to be liable for going forward. Some factors that may impact how to proceed include:

1) If a couple considering divorce is also dealing with difficulty meeting their financial obligations (for example credit cards).

2) Does a couple’s joint income meet the statutory amount to qualify for Chapter 7?[1]  The applicable income parameters are updated on a regular and continuous basis.

3) Is a couple’s real and personal property assets protected by the available statutory protections?

In a Chapter 7 where all assets are protected by statutory exemptions, there are no assets available for liquidation to satisfy the creditors for the debts and liabilities. Generally speaking, the debts would be discharged. In a Chapter 7 where all assets are not protected by statutory exemptions, the non-exempt assets will be liquidated to satisfy the debts and liabilities, and any remaining debts and liabilities not satisfied by the liquidation would be discharged. This results in less attorneys’ fees and costs in a subsequent divorce proceeding, since there would be no debts for the parties to argue over and divide. If a couple is financially struggling, initiating bankruptcy proceedings first is a feasible way to eliminate debts and free up assets to help fund a divorce proceeding. In addition, a couple filing for bankruptcy jointly may qualify for higher equity values of statutory exemptions to protect more assets than filing separately after a divorce where an individual filer would qualify for a smaller equity value for exemption protections. Typically, Chapter 7 is finalized quicker (since there is not a 3-5 year term of plan payments) so couples can conclude the bankruptcy and divorce proceedings in a shorter timeframe. Also, filing for bankruptcy first eliminates the chance that an individual could be responsible for a debt post-divorce that was assigned to the other spouse as part of the Decree because, as discussed above and regardless of the language in the Decree, nothing prevents a creditor from pursuing an ex-spouse for a community debt regardless if the debt was titled in only one person’s name. Therefore, it may be financially beneficial to file for bankruptcy before divorce in a Chapter 7 scenario.

In a Chapter 13 or individual Chapter 11, a couple or individual filing bankruptcy will be required to pay the creditors a portion of their respective monthly income over a period of 3-5 years.  Thus from a practical view, it is more likely that if a couple is considering divorce and qualifies for Chapter 13 or 11, it will likely be more prudent to file for bankruptcy separately after the divorce proceedings have concluded.  If an individual is making support payments as part of the divorce proceeding, it would be helpful to structure the bankruptcy plan payments around those obligations, and it is important for the bankruptcy trustee to factor in the lack of assets and income from the ex-spouse that is divided away as part of the divorce when establishing plan payments.  Dividing the debts through a divorce proceeding may make the payments more feasible at a lower amount, because the amount of debt is theoretically cut in half by dividing the debts between the spouses in advance of bankruptcy. In addition, if one spouse has a high amount of pre-marital debt, it may make financial sense to maintain sole and separate debts throughout the divorce proceedings to engage in a payment plan for the debt after the divorce is finalized. Bankruptcy also may harm an individual’s ability to get financing on a home, so it may make sense to get through divorce proceedings to obtain an exempt qualifying home before filing for bankruptcy. It is important to note that if an individual is contemplating divorce before bankruptcy with the hope that any support obligations will be discharged in bankruptcy, that would be a mistake. Bankruptcy does not discharge any child support or spousal maintenance obligations. In sum, if an individual is anticipating being saddled with a lot of debt as part of the divorce it could make sense to file for Chapter 13 or 11 bankruptcy after a divorce.

Final Thoughts

Bankruptcy and divorce are not synonymous with each other; however, they share similar characteristics with overlapping implications that should be taken into consideration with the assistance of counsel when deciding which process to initiate first. Both bankruptcy and divorce have a similar “new start” upon completion of the process, but there are strategies and benefits to filing one before the other. These considerations are unique to each couple or individual’s case, which is why it is beneficial to work with a full-service firm that can consult in both areas of law to carefully tailor these processes and strategies to the needs of the case.

For more information on this topic, please contact Joel F. Newell, Karen N. Wohlgemuth, or any other members of the Bankruptcy, Restructuring, & Creditors’ Rights or Family Law & Domestic Relations Departments.

[1] https://www.justice.gov/ust/eo/bapcpa/20210401/bci_data/median_income_table.htm

ABOUT THE AUTHORS

Joel F. Newell | Read Bio

Karen N. Wohlgemuth | Read Bio