Divorce and Bankruptcy: What Happens and Best Time To File

Divorce and Bankruptcy: What Happens and Best Time To File

If your marriage is soon to be over and you are struggling with debt, you may be looking to build a new start by dealing with both your legal separation and options to deal with your debt.

Bankruptcy law focuses on resolving debts and providing a fresh financial start. Family law, on the other hand, deals with the division of assets, support payments, and child custody. While these areas of law operate independently, they intersect, and the effect can be quite complicated.

What Happens to Marital Property and Joint Debts in Bankruptcy?

While personal bankruptcy is governed by federal law, divorce is primarily governed by provincial family law. These two laws can intersect, and it’s important to know what will happen to marital assets and joint debt if either spouse files for bankruptcy in Canada.

Treatment of Marital Assets in Bankruptcy

When you file bankruptcy, any assets you own are surrendered to the Licensed Insolvency Trustee to be sold, and the proceeds are then distributed to your creditors to satisfy your debt. This can complicate the division of assets in a divorce.

If you file bankruptcy before your divorce or separation is finalized, your assets will no longer be available to divide between spouses in the divorce. Any share of marital assets owned by the bankrupt spouse will vest with the Licensed Insolvency Trustee.

However, if you file bankruptcy after your divorce, only the assets belonging to the bankrupt spouse under the separation or divorce agreement will become part of the bankruptcy estate.

The family home is often the most significant asset in a marriage. Filing bankruptcy before the divorce is finalized can limit your ability to control what happens to the property. That’s because if there is equity, the ownership that belongs to the bankrupt spouse vests with the trustee, subject to any provincial exemption limits that may protect home equity.

Handling of Joint Debts in Bankruptcy

You and your soon to be ex-spouse are not liable for each other’s debts unless you’ve co-signed the debt. If this happens, they become a joint debt. In Canada, joint debts are considered “joint and several,” meaning each person is fully responsible for the entire debt.

It is important to know that a separation or divorce agreement cannot override your obligation to a creditor for joint debts. Even if your ex-spouse agrees to pay a joint debt as part of the divorce settlement, the creditor can still come after you if they fail to pay.

If one spouse files bankruptcy, the creditors can and will pursue the ex-spouse for payment of a joint debt regardless of what you agreed to in the divorce. To eliminate a joint debt, your lender must agree to remove one spouse from any debt they co-signed or guaranteed. This includes joint credit cards, loans and lines of credit.

Surplus Income and Support Payments

The Role of Surplus Income in Bankruptcy

In a bankruptcy, if your income exceeds certain thresholds, you may be required to make surplus income payments. These payments are based on your family income, which includes your spouse’s income, even if they’re not filing for bankruptcy.

If you file bankruptcy before your divorce, your spouse’s income will become part of your surplus income calculation and can increase the cost of your bankruptcy or consumer proposal.

If you divorce or separate, your required surplus income payments may decline as you will have less family income. Of course, this also depends on which spouse earned the higher income and who is considered responsible for dependents under bankruptcy law.

Support payments also affect your surplus income calculations in bankruptcy. If you’re paying support, these payments are deducted from your income before calculating surplus income. If you’re receiving support, these payments are added to your income.

Does Bankruptcy Eliminate Support or Alimony Payments?

No, bankruptcy does not discharge outstanding or future obligations for alimony or child support payments in Canada.

In fact, support payments are given priority in bankruptcy proceedings. The spouse owed back support payments can make a claim in the bankruptcy and receive their share of any dividend paid from the estate. Any alimony or support arrears for the 12 months prior to the date of bankruptcy are considered a preferred claim and are paid out of the proceeds of the bankrupt estate before any other unsecured claims. Any remaining child or spousal support payments survive bankruptcy.

Unpaid debts due to equalization payments under the terms of a divorce or separation agreement are treated like any other unsecured debt and are eliminated by filing bankruptcy.

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Should You File Bankruptcy Before or After Divorce?

Dealing with divorce and debt simultaneously can feel overwhelming, but there are options available.

Whether you file bankruptcy before or after your divorce is finalized affects whether your creditors will be entitled to any assets that may be part of your divorce agreement.

It is always important to discuss your specific financial situation with your spouse, licensed insolvency trustee, and divorce lawyer; however, here are some considerations regarding the timing of your bankruptcy filing in the event of a divorce or separation.

Filing Bankruptcy Before Divorce

Should you file for bankruptcy or a consumer proposal before divorce?

Pros:

  • If you have significant joint debts, it may make sense for you and your spouse to eliminate them before finalizing your divorce settlement.

  • Eliminating individual debts before separation or divorce can make it easier to afford support payments.

  • If you are threatened with a wage garnishment or seizure of assets by your creditors, filing for bankruptcy or a consumer proposal can stop creditor collection actions while you work to finalize your divorce.

Cons:

  • If you file bankruptcy before your divorce is final, your assets transfer to your bankruptcy estate and are no longer available for distribution in a divorce.

  • Spousal income and shared assets can increase the cost of your bankruptcy or proposal.

Filing Bankruptcy After Divorce

The main reason to complete your divorce proceedings before filing a bankruptcy or consumer proposal is to provide more flexibility in dealing with marital assets.

When should you file for bankruptcy or a consumer proposal after divorce?

Pros:

  • If you finalize your divorce and assets are transferred to an ex-spouse as part of a Family Court Order or legal separation agreement before you file for bankruptcy (assuming it has not been done fraudulently), then these assets are no longer available for your creditors in bankruptcy.

  • If your soon to be ex-spouse earns a much higher income than you do, filing bankruptcy after divorce ensures that income is not included in your surplus income payment calculation.

  • High alimony or support payments could reduce your potential surplus income.

Cons:

  • You may still have the complication of negotiating how marital debts impact equalization payments and asset distribution.

Filing a Consumer Proposal During Divorce

Another way to protect marital assets while eliminating debt is to file a consumer proposal. A consumer proposal is a formal repayment plan negotiated with your creditors through a Licensed Insolvency Trustee.

In a consumer proposal, you keep all your assets. Instead of filing bankruptcy, you negotiate a settlement amount with your creditors to repay a portion of what you owe over a period of up to five years. If you file a consumer proposal, the marital home remains yours and will be distributed when you divorce. However, you are still required to list any assets you own when you file a consumer proposal. Your creditors may want you to pay more because they feel they are entitled to the value of that equity.

If you have substantial property, the solution may be to wait to file a bankruptcy or consumer proposal until after your divorce or separation. If the property is transferred from one spouse to another as part of a family order, legal separation agreement or formalized divorce degree before filing bankruptcy, the property no longer belongs to the potential bankrupt and is now out of reach of the trustee. The separation agreement must be legitimate and not seen to be done for the sole purpose of hiding assets from your creditors.

Filing Insolvency Jointly

While one spouse can file bankruptcy, if you have significant shared debts, it is also possible to file a joint bankruptcy or joint consumer proposal to eliminate the unsecured debt for both spouses. It’s also typically less costly to file together as opposed to doing it apart. This could also make life easier for both of you in a very difficult time.

Divorced couples are still allowed to file a joint consumer proposal or joint bankruptcy to get relief from their combined debts. It is not uncommon for separated couples to find themselves no longer able to repay debts they could manage while married. Divorce changed their financial circumstances. Divorce costs, including legal fees, can lead to divorce debt, and operating two homes can significantly reduce the amount of monthly income available to repay old marital or joint debts.

To determine whether a joint consumer proposal or bankruptcy is the best option, both spouses should contact a Licensed Insolvency Trustee for an assessment of their individual financial obligations.

Dealing With Debt Problems In A Divorce Situation

If you need to file for divorce and bankruptcy, it is very important to seek legal advice from a divorce attorney and financial advice from a Licensed Insolvency Trustee before making any decisions. At Hoyes Michalos, our Licensed Insolvency Trustees can provide personalized guidance to help you make informed decisions about bankruptcy and divorce. Contact us today for a free consultation to explore your options and find the best path forward for your financial future.

Similar Posts:

  1. Who’s Filing Bankruptcy in Their 30s and Why?
  2. How Is Cosigned Debt Treated in a Consumer Proposal?
  3. What Happens to Debt When You Divorce?
  4. Should Married Couples Get a Joint Consolidation Loan?
  5. Does a Consumer Proposal Affect My Spouse?

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