BANKRUPTCY TRAP: Divorce after Bankruptcy

As one court put it, “Neither knaves nor fools should be representing debtors who need legal assistance.” Bankruptcy law is not for the inexperienced, imprudent, or unprepared. Take, for example, a very common situation: divorce after bankruptcy.

It is an unfortunate reality that some debtors divorce after Chapter 7 bankruptcy. In fact, some clients show up for an initial attorney consultation already determined to file divorce “right after the bankruptcy.” For the most part, eliminating financial obligations and obtaining a financial fresh start is a good first step, and alleviating the financial pressures can sometimes even save a marriage.

There are traps along the way for debtors who are intent on divorce after bankruptcy. The most significant is found in Section 541(a)(5) of the Bankruptcy Code which states that property acquired by the debtor within 180 days as a result of a marital property settlement agreement or divorce decree becomes property of the debtor’s bankruptcy estate. Under this statute, a bankruptcy debtor who receives property during a dissolution case will lose it unless the property is already protected with available exemptions.

Cases where a debtor has lost property under this section include a home owned by a husband and wife. The family court awarded the wife full interest in the marital home which was protected during bankruptcy by a tenants by the entireties exemption. Upon divorce within 180 days of the bankruptcy filing, the tenants by the entireties protection was extinguished and the bankruptcy trustee was able to take and sell the home to pay creditors. See In re Cordova, 73 F.3d 38 (4th Cir. 1996).

Other courts have broadly construed Section 541(b)(5) and found that property acquired ”as a result of a property settlement agreement … or of an interlocutory or final divorce decree” includes alimony and spousal support received within six months after the bankruptcy is filed. If these payments cannot be exempted, which is the case in some states, the result is that all payments due in the six months after the bankruptcy filing must be turned over to the trustee. Some courts, including the Court of Appeals for the Tenth Circuit in Peters v. Wise (In re Wise), 346 F.3d 1239 (10th Cir. 2003), and the Bankruptcy Appellate Panel for the Eighth Circuit in In re Jeter, 257 B.R. 907 (B.A.P. 8th Cir. 2001), have held that section 541(a)(5)(B) does not apply to alimony, maintenance or support payments.

Avoiding these traps is fairly simple. First, a debtor who expects to receive property in a dissolution proceeding should avoid commencing a bankruptcy case, unless it is clear that all property that may be awarded in an after bankruptcy dissolution is protected by exemptions. Second, the debtor may delay the award of property beyond the 180 day claw back period. While these tips appear simple and direct, competent legal assistance from an experienced bankruptcy attorney is needed to ensure that the debtor’s actions cannot be construed as efforts to conceal property and otherwise run afoul of the bankruptcy process.