Bankruptcy After Divorce – Why It’s a Bad Idea

When a couple divorces in Arizona, the community property is divided equitably. That means both assets and debts alike. “Equitably” does not necessarily mean “equally” and ultimately the court will make that determination or the parties will come to an agreement. Normally, however, both parties are responsible for a portion of the marital debt. So what happens when one of the parties files for Bankruptcy after the divorce?

The effect of Bankruptcy after divorce is that the party filing the bankruptcy will discharge their portion of the debt onto the other party. Remember, it is community debt so both people are obligated to the creditors. In short, one party becomes solely responsible for all of the marital debt.  When that happens, the equity under the decree is destroyed. You may be thinking, well why wouldn’t the other party file for bankruptcy too? Most times, the other party does not qualify to file for bankruptcy because they earn more than what is allowed under a Chapter 7 bankruptcy. While one can discharge their obligations to creditors, they cannot discharge their obligations under a court order.

According to Birt v. Birt, a case out of the Arizona Court of Appeals, the Superior court shall vacate portions of the decree and consider whether reallocating community property is appropriate in light of the changed circumstances due to one party discharging community debts through bankruptcy too soon after a divorce.

In plain language, the parties can re-open the property division in their divorce decree when one party is substantially harmed by the other party’s bankruptcy. The good news is there is recourse through the courts, the bad news is reopening the property division is like going through another divorce. The time, expense of hiring counsel, rehashing old arguments and more. The risk then in re-opening the property division is that everything is revisited. This could end up being a negative if something had not been addressed in the original decree. For example, if one of the parties had a business that was not included in the original decree, you now are looking at including the value of that business. In order to properly place value on a business, one must hire a business valuator to do an analysis. The business valuator alone costs anywhere between $5,000 to $10,000. That does not include hiring the business valuator as an expert witness for trial. Another negative that is all too common is when the community was comprised of mostly debts and very few assets.

The damage does not stop there. When the property is re-opened child support and spousal maintenance is recalculated. The end result could mean the deal you get is worse than in the first divorce.

The irony is, one person files for bankruptcy because they can’t afford their debts after the divorce then end up paying an attorney thousands and thousands of dollars on a “second divorce.”  The fees incurred could easily be greater than the debt that was discharged in bankruptcy.

The best practice is to not only go through your dissolution proceedings thoroughly to minimize areas that could be affected after the divorce, but then not to do anything that may destroy the obligations under that agreement or you will be back in court. The only circumstance where one should seek a bankruptcy after divorce is if the parties agreed to filing for bankruptcy under the decree.

Site Updates in Progress. Thanks for your patience!