Bankruptcy in Amicable Divorce
If a husband and wife are in the fortunate position of remaining on relatively civil terms as they contemplate a divorce and a potential bankruptcy for one or both, some advance strategic planning can improve their post-divorce financial situations. A joint bankruptcy petition filed prior to divorce can save on filing and attorney’s fees, but could also reduce the total amount of property that could be exempted from the bankruptcy estate. If one spouse has significant separate property and no personal liability for some or all of the other spouses’ debts, the bankruptcy of only the personally liable spouse prior to divorce may be advantageous. This will at least preserve the non-debtor spouse’s separate property, and may leave more property to be considered and distributed at dissolution.
It might also be possible, if a couple determines the desirability of divorce and the imminence of bankruptcy far enough in advance, to transmute a significant amount of community property into separate property prior to the two-year avoidance window in bankruptcy law. Fraudulent transfer laws may be applicable to the transmutation. Regardless of the time constraints, a transfer of property interests for reasonably equivalent value in the course of settlement negotiations might still allow insulation of some property from the grasp of the trustee, and may result in a lower post-divorce support burden for the debtor spouse. A transfer of the potential debtor’s interest in a marital home to the other spouse in exchange for a release of future support obligations may be an example of such a transmuting transaction.
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While potentially very advantageous to both the potential debtor and the non-debtor spouse, these transactions must be carefully planned in order to avoid the possibility that the bankruptcy trustee will be able to avoid the transfer as fraudulent and reassert control over the property. It is highly advisable to seek a bankruptcy practitioner’s guidance before contemplating or consummating such a transaction.