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How Chapter 7 and Chapter 13 Bankruptcy Affect Debt Discharge in a Divorce or Dissolution

October 6, 2021
Filing for bankruptcy

SERIES: Bankruptcy and Distressed Property in a Domestic Relations Matter
Part 1- How Bankruptcy Affects Distressed Property in Divorce or Dissolution: The Basics
Part 2- What is an Automatic Stay and How Does it Affect Divorce?
YOU ARE HERE: Part 3- How Chapter 7 and Chapter 13 Bankruptcy Affect Debt Discharge in a Divorce or Dissolution

 

The first two articles in this three-part series have explored bankruptcy lawsuits and the implications of the same, particularly as it concerns distressed property in a domestic relations (i.e. divorce or dissolution) matter. In the most recent article, we discussed the “automatic stay” in a bankruptcy lawsuit and how it can add a procedural complication to a domestic relations matter.

In this third and final installment, we address the differences between a Chapter 7 and a Chapter 13 bankruptcy proceeding, and the potential implications that those differences may have for a domestic relations action, both in the immediate and long-term. Notably, while Chapter 7 and Chapter 13 bankruptcy proceedings are certainly not the only types of commonly-filed bankruptcy lawsuits, we will limit our discussion in this article to these two types for the sake of simplicity.

Chapter 7 vs. Chapter 13 Bankruptcy

As an initial matter, it is important to note that a party to a bankruptcy proceeding does not necessarily always get a choice as to whether they will pursue relief under Chapter 7 or Chapter 13 of the Bankruptcy Code. Certain factors—including the income of the relevant party, the value of the property held by the party, and the debts of the party, among others—can dictate which type of filing, in particular, Chapter 7 or Chapter 13, a party should or can pursue.

Chapter 7: Liquidation

A Chapter 7 bankruptcy proceeding is best understood as a liquidation. Specifically, in a Chapter 7 bankruptcy proceeding, the bankruptcy court and the bankruptcy trustee are there to gather and liquidate the non-exempt assets of the debtor (if any) in order to, as much as reasonably possible, pay the creditors at issue in order of priority. At the end of a Chapter 7 bankruptcy proceeding, the debtor receives a discharge (i.e. elimination) of those of his or her debts that are, in fact, dischargeable. From initiation until discharge, a Chapter 7 bankruptcy proceeding typically lasts a few months.

Chapter 13: Restructuring

In contrast, a Chapter 13 bankruptcy proceeding is best understood as a restructuring. One of the hallmarks of a Chapter 13 bankruptcy is the Chapter 13 Plan which must be approved by the bankruptcy court and with which the debtor must comply during the Chapter 13 proceeding. The Chapter 13 Plan is, in effect, the debtor’s blueprint to the court for how he or she intends to repay some portion of the debt at issue. Most Chapter 13 Plans, typically, last 3 – 5 years and are funded with the debtor’s income and/or the sale of the debtor’s assets. However, in order to receive a discharge of his or her remaining debt, the Chapter 13 debtor must have completed and complied with the Chapter 13 Plan at issue. Thus, a Chapter 13 debtor may have to wait 3 – 5 years before he or she receives a discharge—and that’s only assuming that he or she complied with and completed the Chapter 13 Plan. Accordingly, in a Chapter 13 bankruptcy proceeding, the bankruptcy court and the bankruptcy trustee are there to ensure that the debtor is treating his or her creditors fairly and that he or she is complying with the Chapter 13 Plan. Notably, however, the discharge that is received in connection with a Chapter 13 bankruptcy proceeding is more substantial in scope than the one received in connection with a Chapter 7 proceeding.

So, how do the differences between a Chapter 7 and Chapter 13 bankruptcy proceeding impact a domestic relations proceeding?

How Chapter 7 and Chapter 13 Affect Divorce or Dissolution

First, one way that a Chapter 7 bankruptcy proceeding and a Chapter 13 bankruptcy proceeding can impact a domestic relations proceeding differently is by and through the “automatic stay,” which we discussed in detail in the second article in this series. Quite simply, because a Chapter 7 bankruptcy proceeding typically only lasts a matter of months, while a Chapter 13 bankruptcy proceeding usually lasts between 3 – 5 years, the “automatic stay” will generally have a much greater impact, practically speaking, on domestic relations cases where a Chapter 13 bankruptcy is pending versus a Chapter 7 bankruptcy.

Second, the other main way that a Chapter 7 bankruptcy proceeding and a Chapter 13 bankruptcy proceeding can impact a domestic relations lawsuit differently is by and through the types of debt that can be discharged in each respective type of proceeding. Indeed, as alluded to above, not all debts are dischargeable—and thus, are not discharged—at the end of a bankruptcy proceeding. In fact, examples of typically non-dischargeable debts, regardless of which type of bankruptcy proceeding is pending, include student loan debt and tax debts, among others.

What is a DSO?

In our last article, we touched, briefly, on the concept of a Domestic Support Obligation (“DSO”). As a refresher, a DSO, as a general matter, is a debt that is owed to or recoverable by a spouse, former spouse, child of the debtor, or similar category of person, which is in the nature of alimony, maintenance or support, and is established pursuant to a divorce settlement agreement or court order. Again, think of DSOs as what is generally understood as child support and spousal support.

By statute, DSO’s are non-dischargeable and have the highest priority in any bankruptcy proceeding, meaning that such claims do not disappear at the end of the bankruptcy, and they are assigned a bigger piece of the pie when the bankruptcy estate is being divided up by the trustee. This is true in both Chapter 7 and Chapter 13 proceedings. Accordingly, debts and obligations for spousal support and child support that originate from a domestic relations proceeding are, typically, not dischargeable in bankruptcy proceedings and maintain the highest priority for repayment.

Notably, however, the debts and obligations that originate from a domestic relations matter are, typically, not limited to support-related liabilities. To be sure, at the conclusion of a domestic relations matter, spouses may owe to each other certain additional sums—via lump sum, installment payments, or otherwise—to equalize certain other property or debt divisions. Similarly, at the conclusion of a domestic relations matter, a spouse may agree, in exchange for something else of value, to take on full responsibility for the repayment of certain marital debt in connection with a final settlement, when they might have otherwise only had to be responsible for a portion of that same marital obligation. While these types of obligations may not necessarily fall into the box of a traditional DSO, they clearly still have value worth protecting to the spouse who is supposed to receive the same. So, how are these types of non-DSO obligations treated in connection with a bankruptcy proceeding?

Whether DSO’s Are dischargeable Depends on The Type of Bankruptcy Proceeding

The answer to that question likely depends on what type of bankruptcy proceeding is pending. In fact, in a Chapter 7 proceeding, these types of non-DSO liabilities owed to a spouse, former spouse, child, or similar category of person which originated from a domestic relations matter are likely non-dischargeable. However, because a Chapter 13 discharge is greater than a Chapter 7 discharge, these non-DSO liabilities may be dischargeable, at least in part, in a Chapter 13 proceeding, unless the former spouse or affected party affirmatively asserts his or her claim in the bankruptcy proceeding.

Key Takeaways

So, what does this all mean?

Quite simply: just because your marriage to your former spouse is terminated, that, unfortunately, does not mean that you inherently won’t continue to be affected by his or her subsequent financial decisions, especially if funds are still owed in connection with your prior domestic relations matter. Yet, this also does not mean that you have no available recourse, to the extent these or similar circumstances occur. However, given the complexity of these situations, acting swiftly to identify your available options—as well as retaining experienced legal counsel who can assist you in navigating the nuances of these issues—is critical.

At KJK Family Law, we understand just how overwhelming navigating these and similar issues can be, especially during an already stressful time. But you don’t need to go it alone. For further guidance on these and other related matters, please contact John D. Ramsey (jdr@kjk.com), Janet R. Stewart (js@kjk.com), or another member of KJK Family Law by calling 216-696-8700.

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