When Divorce and Bankruptcy Collide

If you are looking at filing for divorce and bankruptcy, which do you do first? Couples may choose to file for bankruptcy jointly before getting a divorce. This will allow them to discharge both parties’ debts before filing for divorce and taking the issue of debt division out of the divorce process as much of their unsecured debts have been eliminated or discharged. The exemptions allowed also play a role in whether you file for bankruptcy before or after a divorce. If there is a joint filing, you may be able to double the allowable exemptions which may also be an incentive to file for bankruptcy before a divorce if you have assets to protect.

What is Exempt in Illinois (What You Can Keep When Filing Bankruptcy)

If you are filing for bankruptcy in Illinois, the law allows you to keep certain personal property and excludes them from the bankruptcy.  Here is a list of those exemptions:

• Homestead – up to $15,000 in equity in your home
• Motor Vehicle – up to $2,400 in one motor vehicle
• “Wildcard” Exemption – If an exemption amount does not cover personal property that you would like to keep (does not include real estate) you can use this exemption or use it for an item that is not protected up to $4,000
• Alimony, Support, and Maintenance – the amount reasonably necessary for support.
• Cemeteries and Burial Funds – pre-need cemetery sales and future care funds
• Claims for Negligence or Tortious Conduct – payment made to you from a wrongful death of a person who was your dependent to the extent reasonably necessary for your support and a personal injury award up to $15,000
• Crime Victim’s Compensation – 100% of any compensation for a crime
• Franchise, Permit, and License Interests including liquor permits
• Fraternal Benefit Society Benefits – 100%
• Insurance Benefits – Life insurance, annuity proceeds, or cash value if the beneficiary is insured’s child, parent, spouse, or another dependent
• Life insurance proceeds to a spouse or dependent – to extent needed for support
• Health, disability, or unemployment benefits
• Partnership Property – under the Illinois Uniform Partnership Act
• Pension and Retirement Benefits
• Personal Property such as necessary – wearing apparel; bible and school books; family pictures; professionally prescribed health aids; a certificate of title to any a watercraft over 12 feet in length; prepaid tuition trust fund; Illinois College Savings Pool accounts invested more than one year before filing if below federal gift tax limit, or two years before filing if above
• Public Assistance – 100% exempt
• Trade Implements – $1,500 in all tools of your trade
• Unemployment Compensation – 100% except for certain child support claims
• Wages – 85% of your gross earnings or 45 times the federal minimum hourly wage per week, whichever is greater
• Worker’s Compensation -100% exempt
• Veteran’s Benefits – 100% exempt

In Chapter 7 bankruptcy, a bankruptcy trustee sells property that is not exempt and uses the proceeds of the sale to pay your debts. In Chapter 13 bankruptcy, you keep all your assets and pay the value of the property that is not exempt to unsecured creditors (credit cards, utility bills, etc.) over a period of time which is generally a repayment plan that takes 3 to 5 years.

How long does bankruptcy take?

If a couple is filing a Chapter 7 bankruptcy it can be completed in a few months. However, if they are filing for Chapter 13 bankruptcy, the process takes several years to complete since a repayment plan that has to be completed before discharge and that generally takes between three to five years.

Impact of the Bankruptcy Abuse Prevention & Consumer Protection Act of 2005

People used to file Chapter 7 frequently, but in 2005 an amended to the Bankruptcy Laws changed this. Known as the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), it is now more difficult to file for bankruptcy under Chapter 7 (which is where most of the debtors’ debts are forgiven or “discharged”). Instead, more bankruptcy filings under Chapter 13 where debts are discharged only after repayment of some portion of the debts. Another change under BAPCPA is that you may not be able to discharge an obligation to pay a debt listed as property division in a marital settlement agreement or Judgment for Dissolution of Marriage.

Bankruptcy Cannot Discharge Spousal Support or Child Support Obligations

Domestic Support Obligations generally cannot be discharged in bankruptcy. Under the Bankruptcy Code states that:

“A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) does not discharge an individual debtor from any debt- to a spouse, former spouse, or child of the debtor and not of the kind described in paragraph (5) that is incurred by the debtor in the course of a divorce or separation or in connection with a separation agreement, divorce decree or other order of a court of record, or a determination made in accordance with State or territorial law by a governmental unit.”
Paragraph (5) is the exception known as “domestic support obligation”. Domestic Support Obligation is defined as a debt that accrues before, on, or after the date of bankruptcy discharge, that is
(A) owed to or recoverable by a spouse, former spouse, their child or their child’s parent, legal guardian, or responsible relative or a governmental unit.
(B) in the nature of alimony, maintenance, or support (including government assistance) of a spouse, former spouse, their child or child’s parent.
(C) established or subject to establishment before, on, or after the date of bankruptcy discharge by a (i) a separation agreement, divorce decree, or property settlement agreement or (ii) an order of court; or (iii) a determination made in accordance with applicable nonbankruptcy law by a governmental unit; and
(D) not assigned to a nongovernmental entity, unless that obligation is assigned voluntarily by the spouse, former spouse, child or child’s parent, legal guardian, or responsible relative for the purpose of collecting the debt. [11 U.S.C. 523(a)(15)]

Creditors and Dividing Debts in Divorce

You should be aware that the division of debts in a divorce does not affect each spouse’s liability to a third-party creditor like a credit card company. The credit card company is not a party to your divorce and the divorce court cannot undo any contract you have with your creditors. Even if there is an agreement that one party will pay certain debts or the court orders one party to pay a certain credit card, a creditor can attempt to collect a debt from either spouse. If the spouse who agreed to pay the debt fails to pay, the credit card company will come after the other spouse – for sure if that other spouse is listed as a cardholder on the credit card. You may have a right to seek reimbursement from your ex-spouse who failed to pay the debt they were ordered to pay, but this can be time-consuming and expensive. To avoid this problem, the spouses may want to get their debts discharged through bankruptcy before getting a divorce.

Addressing Division of Debt in the Marital Settlement Agreement

However, if there is debt to be divided, thoughtful drafting of a Marital Settlement Agreement is required. If one spouse agreed to pay credit card debt and discharges those debts in bankruptcy – this leaves the other spouse open to have to pay those if the credit card company comes after the other spouse. It is not always safe if the credit card is only in the name of the spouse that assumes the debt. In that case, if that spouse files for bankruptcy and the credit card debt is discharged, the Credit Card Company can still come after the other spouse who was not named on the credit card account under provisions of the Family Expense Act.

Impact of the Family Expense Act

The Family Expense Act provides that the expenses of the family and of the education of the children shall be chargeable upon the property of both husband and wife in favor of creditors and may be sued jointly or separately. First, it has to be a family expense that was incurred on the credit cards or, if it was not a family expense, that the expense was agreed to by the other spouse, or was for goods or merchandise purchased by or is in the possession of the other spouse. It may be rare for a creditor to come after a spouse that was not a named cardholder but it can happen and you must be aware.

Family Expenses under Illinois Law

• Illinois has determined that the following are family expenses:
• Medical bills,
• Funeral expenses,
• Clothing,
• Jewelry,
• Rent for the family home,
• Repairs for the family home, and
• Wages for a domestic servant.

This list is not all-inclusive but just an example of those things that are considered family expenses in Illinois.

Filing Bankruptcy During the Divorce Process

When a spouse files for bankruptcy during the pendency of a divorce case – when the divorce is not yet final – there is an automatic stay provision that goes into effect that will likely delay the division of property until the bankruptcy is complete or the automatic stay is lifted by the bankruptcy court. This requires a continuance for any trial or court date to finalize a divorce so that the attorneys can go into Bankruptcy Court and lift the Automatic Stay that goes into effect as soon as someone files for Bankruptcy. The automatic stay stops collectors from contacting you once you file but also precludes a divorce court from diving the property which is now part of your bankruptcy estate.

Bankruptcy and Discharge of Student Loan Debt

An interesting decision came down recently where a bankruptcy judge ruled that $220,000 in student loan debt can be discharged. It has often been said that you cannot discharge student loan debt to the Federal Government. However, in this case, the debtor had an annual income less than $38,000, and his monthly income after expenses left him short $1,500 so according to the January 7, 2020 opinion by Chief U.S. Bankruptcy Judge Cecelia Morris of the Southern District of New York, the student loan debt was in fact dischargeable. Judge Morris considered whether the debtor could maintain a minimal standard of living if forced to repay the loans, whether an inability to maintain the minimum standard is likely to persist for a significant portion of the repayment period, and whether the debtor had made a good faith effort to repay the loans. Based on these factors, the debtor was entitled to discharge the student loan debt.

Consult with an Experienced Chicago Divorce Attorney Before Your File for Bankruptcy

There is not one best approach for everyone as each case has its own facts and set of circumstances that require consideration. If you are in the middle of a divorce or plan on filing for divorce and believe that bankruptcy will also be an issue, these matters should be discussed with your divorce attorney and a qualified bankruptcy attorney before any decision is made.