Making Sense of Bankruptcy: How Do You Choose between Chapter 7 and 13 If You Owe Money to Your Ex-Spouse?
There are two post-divorce situations in which the extra time and expense of a Chapter 13 case could be well worthwhile.
Here’s the sentence that we’re explaining today:
If much of your financial problems come from debts owed your ex-spouse, then when deciding between Chapter 7 “straight bankruptcy” or Chapter 13 “adjustment of debts” the latter can help more if you either 1) are behind on child or spousal support or 2) owe a substantial amount of non-support debt to your ex-spouse.
Debts Owed to Ex-Spouse
To understand how Chapter 7 and 13 bankruptcy deals with debts from a divorce (or legal separation) we first need to understand the distinction between two kinds of divorce debts. Bankruptcy law divides them into 1) support and 2) property settlement obligations.
1) Debts “in the nature of alimony, maintenance, or support” include regular child and spousal support, but can be broader. The decree doesn’t necessarily need to label the obligation as support for bankruptcy law to treat it as support. For example, a decree ordering you to pay certain ongoing expenses of a child, such as health insurance premiums, could be considered “in the nature of” support. Even an obligation to pay an ex-spouse’s attorney fees incurred addressing support-related issues might be considered “in the nature of support.”
2) “Property settlement” debts are those not “in the nature of” support but rather involving the division of marital assets and debts. Besides specifying which spouse gets which asset, the divorce decree can require one person to pay the other a certain amount of money to compensate for getting more of the assets. The decree can also order one spouse to pay the entire balance of a jointly owed debt, or to pay a debt that is owed by the other spouse.
Whether a debt referred to in a divorce decree is a support or property settlement kind of debt is usually obvious from the language of the divorce (or separation) decree. But not always. Any dispute about this is decided by the bankruptcy court based on bankruptcy law, not the divorce court.
Chapter 7 and Chapter 13
In case you don’t already know, Chapter 7 is usually a quick procedure, lasting only about three months. Its purpose is to give immediate relief from creditor pressure, determine if you own anything that is not protected from creditors, and then discharge (legally write off) most or all of your debts to give you a fresh financial start.
Chapter 13 is very different, involving a court-approved multi-year payment plan through which creditors are paid or not paid based on a set of rules. The protection from creditors lasts not just a few months but the 3-to-5 years that most cases take. So Chapter 13 often buys time to pay certain kinds of debts, either to preserve collateral (like a home or vehicle) or to pay off a debt that can’t be discharged. Usually a significant portion of the remaining debts are discharged at the end of the case.
Chapter 7 is generally appropriate for more straightforward situations, Chapter 13 for situations in which there are special debts that it handles better than a Chapter 7 case could—such as support arrearage and non-support debts.
Curing Support Arrearage
Neither Chapter 7 nor Chapter 13 can discharge any support obligations. But if you are behind on support payments Chapter 13 can help in a crucial way, by stopping the collection of back support and giving you time to catch up. Outside of Chapter 13, support can be collected through very aggressive means, including the potential suspension of your driver’s license, and possibly even of an occupational or professional license.
The filing of a Chapter 7 case does not stop such collection of back support at all. The only way it helps is by discharging your other obligations so that you can catch up on the support as quickly as possible.
In contrast, the filing of a Chapter 13 case immediately stops all efforts to collect back support. And then is resolves the situation permanently as long as 1) you pay any regular support payments on time from then on, 2) your Chapter 13 plan includes paying off the entire support arrearage during the life of the plan, and 3) you in fact bring the support obligation current before the end of your case.
The Discharge of Property Settlement Debts
Although Chapter 13 does not discharge support obligations, it can discharge part or all of the property settlement obligations.
For example, if your divorce decree requires you to pay your ex-spouse $10,000 to make up for you getting more marital assets, that debt likely would be seen as not a “in the nature of support” but rather as a property settlement obligation. Therefore, this divorce debt could be discharged in a Chapter 13 case. You may need to pay something on it through the payment plan during the life of the case, but only if you could reasonably afford to do so. Paying pennies on the dollar on that debt would be much better than having to pay it in full if you filed a Chapter 7 case instead.
So, if you are behind on your child or spousal support, or if you owe a substantial property settlement debt, Chapter 13 could deal with these obligations much better than could a Chapter 7 case.