Divorce and bankruptcy seem to go together. If you are throwing away your personal life, why not also throw away your professional life? Promises, after all, are made to be broken.
How Bankruptcy Works
“The central purpose of the Bankruptcy Code is to give a fresh start to the honest but unlucky debtor.” Schroeder v. Winyard, 873 NE 2d 35 – Ill: Appellate Court, 2nd Dist. 2007 (citations omitted)
The relief in a bankruptcy is the discharge of debt.
“When a…bankruptcy petition is filed, a new bankruptcy “estate” is created, and the estate is made up of all of the debtor’s property at the time the case commences.” Holland v. Schwan’s Home Service, Inc., 992 NE 2d 43 – Ill: Appellate Court, 5th Dist. 2013
In exchange for this discharge of debts, the bankruptcy trustee takes control of the bankruptcy petitioner’s assets to create a bankruptcy estate.
The bankruptcy estate includes “all legal or equitable interests of the debtor in property as of the commencement of the case.” 11 U.S.C. § 541(a)(1) (2006)
These assets then may be sold to satisfy various creditors.
“The trustee, after notice and a hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate” 11 U.S.C. § 363(2006)
But what if your bankrupting spouse’s assets are also your assets?
Marital Assets In An Illinois Bankruptcy
The bankruptcy estate will not include assets in the spouse’s name or presume your assets also belong to your spouse.
A bankruptcy estate will include “[a]ll interests of the debtor and the debtor’s spouse in community property as of the commencement of the case” 11 U.S.C. § 541(a)(2) (2006)
In Illinois, marital assets are divisible. “‘[M]arital property’ means all property, including debts and other obligations, acquired by either spouse subsequent to the marriage” 750 ILCS 5/503(a)
Once an asset is classified as a marital asset by an Illinois divorce court, the Illinois divorce court “shall divide the marital property without regard to marital misconduct in just proportions” 750 ILCS 5/503(d)
If that marital property is part of the bankruptcy estate of one spouse…the marital property may be sold to satisfy the spouse’s debts…unless you do something about it.
Marital property of the spouse NOT declaring bankruptcy should NOT be part of the bankruptcy estate.
“Even if the debtor spouse has actual possession of the [asset], the nondebtor’s interest in the [asset] is still that nondebtor spouse’s separate property and does not become property of the [bankruptcy] estate.” In re Brown, 168 B.R. 331, 335 (Bankr. N.D. Ill. 1994)
The spouse of a bankruptcy petitioner may be able to preserve their marital assets from the bankruptcy estate with a few deft legal maneuvers.
Any attempt to file bankruptcy and liquidate marital assets must countered by a petition to declare the marital assets part of a constructive trust. The creation of a trust forces the bankrupting spouse to preserve the non-bankrupting spouse’s share.
“[T]he trustee’s holding of legal title to the property and his actions with respect to that property are determined by the instrument which creates the trust.” Shakman v. Department of Revenue, 2019 IL App (1st) 182197, ¶ 26
“It is a fundamental and wholesome provision of the law which requires a trustee must act in good faith in the administration of his trust, and that requirement means that he must act honestly and with finest and undivided loyalty to his trust” Sauvage v. Gallaway, 329 Ill. App. 38, 44 (Ill. App. Ct. 1946)
After the trust is created, it is up to the bankruptcy trustee and court to acknowledge that the spouse’s portion of the marital estate is not to be included in the bankruptcy estate. State courts cannot modify or overrule a Federal Bankruptcy court. Cassidy v. Kentner, 235 Ill. App. 3d 114, 115 (Ill. App. Ct. 1992)
If a bankrupting spouse does liquidate marital assets in a bankruptcy, that could be deemed a dissipation of marital assets and the bankrupt spouse would have to return their spouse’s share to their spouse. This begs the question of where are they going to get that money after bankruptcy?
Marital Debts in An Illinois Bankruptcy
A spouse’s bankruptcy is not all bad, any bankruptcy of a spouse eliminates debt that would otherwise be allocated to either spouse.
Marital property, in an Illinois divorce also includes Marital debt. ““”marital property” means all property, including debts and other obligations, acquired by either spouse subsequent to the marriage” 750 ILCS 503(a) (emphasis mine)
“It is well settled that marital debts as well as marital assets must be distributed equitably.” In re Marriage of Lees, 224 Ill. App. 3d 691, 693 (Ill. App. Ct. 1992)
The non-bankrupt spouse can still seek contribution to their debts from the spouse who did file for bankruptcy…even though that spouse discharged all the debts in their own name.
“Requiring [a bankruptcy petitioning spouse] to pay [the spouse who did not file for bankruptcy] for a portion of the marital debts he left her with is not contrary to the Bankruptcy Code. While [the bankruptcy petitioning spouse’s] liability to the creditors was obviously discharged by the bankruptcy proceedings, we do not find that those proceedings discharged his liability to the marriage resulting from the subsequent divorce.” In re Marriage of Cesaretti, 561 NE 2d 306 – Ill: Appellate Court, 2nd Dist. 1990
“While [a bankrupt spouse’s] liability to the creditors was obviously discharged by the bankruptcy proceedings, those proceedings did not discharge [the bankrupt spouse’s] obligations to the marriage resulting from its dissolution.” In re Marriage of Lees, 224 Ill. App. 3d 691, 694 (Ill. App. Ct. 1992)
Bankruptcy and Child Support And Maintenance In Illinois.
“A discharge under [U.S. bankruptcy laws] does not discharge an individual debtor from any debt…for a domestic support obligation [or] to a spouse, former spouse, or child of the debtor and not of the kind described in paragraph (5) that is incurred by the debtor in the course of a divorce or separation or in connection with a separation agreement, divorce decree or other order of a court of record, or a determination made in accordance with State or territorial law by a governmental unit” 11 U.S. Code § 523(a)(5),(15)
These support obligations can proceed smoothly during a divorce action while the rest of the divorce is frozen by an automatic stay.
There is no automatic stay for “for the establishment or modification of an order for domestic support obligations” 11 U.S.C. §362(b)(2)(A)(ii)
Divorce During Bankruptcy
A bankruptcy filing does throw a massive wrench into ongoing divorce proceedings.
“[A] petition [for bankruptcy] operates as a stay…any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate” 11 U.S.C. §362(a)(3)
A stay is “the postponement or halting of a proceeding, judgment of the like” Black’s Law Dictionary (11th ed. 2019)
Realistically, this stay only applies to the division of assets and debts in an Illinois divorce. The following are exempted from the stay and can proceed despite the bankruptcy filing:
- Establishment of paternity ; 11 U.S.C. §362(b)(2)(A)(i)
- Establishment or modification of an order for domestic support obligations (child support or alimony); 11 U.S.C. §362(b)(2)(A)(ii)
- Custody of visitation; 11 U.S.C. §362(b)(2)(A)(iii)
- Getting the actual divorce decree (unless the proceeding seeks equitable distribution of property of the estate); 11 U.S.C. §362(b)(2)(A)(iv),
- Domestic violence. 11 U.S.C. §362(b)(2)(A)(v).
Attorney’s Fees And Bankruptcy In Illinois
Divorcing spouses are often ordered to pay their attorneys and their spouse/ex-spouse’s attorney fees.
“The court from time to time, after due notice and hearing, and after considering the financial resources of the parties, may order any party to pay a reasonable amount for his own or the other party’s costs and attorney’s fees.” 750 ILCS 5/508(a)
These attorney’s fees are independent of an obligation to a spouse. “Attorneys in a divorce proceeding are parties in interest in an action for attorney fees and have standing to pursue the action themselves.” In Re Marriage of Dague, 136 Ill. App. 3d 297 ( 1st Dist. 1985).
What better revenge on your spouse’s divorce attorney than to discharge the divorce attorney’s ordered fees in bankruptcy? Well, attorney fees are not dischargeable in bankruptcy if those attorney’s fees are associated with child support or maintenance.
“Attorney’s fees that are in the nature of maintenance or support can be nondischargeable under § 523(a)(5) even if payable directly to the attorney.” In re Kline, 65 F.3d 749, 750 (8th Cir.1995)
When someone files for bankruptcy, they do NOT want to pay anyone…least of all their former spouse or soon-to-be former spouse. Make sure your divorce lawyer understands how bankruptcy impacts a divorce or a post-judgment divorce proceeding.