Written by Eric S. Steiner, Esquire.
Bankruptcy and divorce combine two complex legal proceedings, and divorces contribute to 24.4% of bankruptcies filed nationwide. The Collaborative Practice process can be used to assist both spouses to structure a divorce in anticipation of one or both spouses filing for bankruptcy.
1. Bankruptcy and Divorce – The Differences Between Chapter 7 and Chapter 13.
When thinking about bankruptcy and divorce through the collaborative process, it is first important to understand some of the differences between Chapter 7 and Chapter 13. Chapter 7 bankruptcy is the liquidation chapter, and is useful to discharge credit card debt, personal loans, medical debt, and in some cases, tax debt. Generally, in order to qualify for a Chapter 7, the bankruptcy filer – called the “debtor” – must meet the Means Test. The Means Test first looks at the household’s gross income over the 6 months prior to filing for bankruptcy, as well as the household size, and compares the gross income over the past 6 months to the median income for the State of Maryland for that household size. For example, if a married couple has two children, the median income for the State of Maryland for a four-person household is $125,989.00. As long as the household income over the past 6 months before filing is less than $125,989.00, one of both of the spouses will not have a Means Test issue. However, if the household income over the past 6 months before filing bankruptcy is over $125,989.00, the debtor has a presumption of abuse of the Chapter 7 process which must be overcome.
A Chapter 13 bankruptcy is a more powerful chapter than Chapter 7 bankruptcy, and is useful to not only address credit card debt, personal loans, medical debt, and taxes, but also for bringing arrears on a mortgage current and stopping foreclosure proceedings. In a Chapter 13 bankruptcy, the debtor is placed into a 3 to 5-year payment plan, and the duration of the plan can be determined by the Means Test figures. A Chapter 13 bankruptcy can also adjust certain secured debts, such as car loans, to lower the monthly payment over the course of the 3 to 5-year payment plan.
2. Bankruptcy and Divorce Through the Collaborative Process – Understanding How Property is Titled.
When going through the collaborative process for bankruptcy and divorce, taking into account the effect of how the marital home is titled is of utmost importance to ensure that the marital home is protected if bankruptcy is filed. When couples are married, their home is often titled as tenancy by the entirety, which offers protections from creditors. When a property is titled as tenancy by the entirety, creditors of one spouse only cannot collect against the property, other than taxing authorities such as the IRS and State of Maryland. If, for example, only one spouse has debt for which they are exploring bankruptcy, property titled as tenancy by the entirety would protect the property from those creditors if it has equity. However, upon divorce, the property title changes to tenants in common which does not offer the protections provided by tenancy by the entirety.
3. Bankruptcy and Divorce Through the Collaborative Process – Household Income and Expenses for Chapter 7 and Chapter 13.
Another important consideration when filing for bankruptcy while going through divorce are the calculations of household income and expenses. If both spouses are married and living together, the income of both spouses must be used in bankruptcy, and the expenses of both spouses are used. If the spouses are not living together, only one spouse’s income – and therefore expenses – is used. A large enough surplus of income over expenses can make the difference between whether or not the debtor can file under Chapter 7 or Chapter 13.
Another bankruptcy income consideration is both the amount and timing of alimony and child support payments. In the collaborative process, the spouses can structure child support and alimony payments with a close look at how these payments factor into the Means Test as well as the bankruptcy budget.
4. Bankruptcy and Divorce Through the Collaborative Process – Household Size for Chapter 7 and Chapter 13.
Household size comes into play when planning for bankruptcy while going through divorce through the collaborative process. In Maryland, household size is defined under the “heads on beds” standard, and so long as a dependent lives with one spouse 51% or more of the time, the debtor can include that dependent for bankruptcy household size purposes. Household size in bankruptcy also affects what monthly expenses are considered reasonable, and whether or not the Means Test is implicated in a Chapter 7 or Chapter 13.
In the collaborative process, if only one spouse is considering bankruptcy, fashioning a parenting plan so that children live with that spouse at least 51% of the time can greatly affect how a bankruptcy is structured.