Divorces Divide (and Create!) Debts, Too

The fallout from dissolving a marriage is one of the leading factors for people filing bankruptcy. Simple math tells you why: Taking the income for one household and trying to spread it across two households, one of which is often the first household with only one person removed. Unless the savings rate for a family is 50% or more, that transition will surely come with some significant financial consequences.

Yet ask most people what they think about first (well, after child custody) when thinking about the impact of divorce, and the answer is likely the division of assets - who gets the house, the car, the 401(k). Little attention is paid to who pays the debts of the divided union; but it is exactly these that have more impact on family budgets going forward.  It doesn’t matter who gets the car, if the car payment isn’t made.

A common clause in divorce decrees is an indemnity clause, that requires one spouse to pay a debt, and to be liable to the other spouse in the case of default. Many prospective clients believe this will protect them from actions of the creditor. Unfortunately, all it does is give a right of recovery against the defaulting spouse after you, the injured party, pays money to settle the debt.

In this way, a divorce decree sets up a triangle of obligations. The first two sides of the triangle are your obligation to the creditor and the former spouse’s obligation to the creditor.  These are created by the contract with the creditor, and nothing in the divorce decree has any legal effect on that obligation. The third side is the obligation between spouses, created by the divorce decree.  So while that third side is worth something, it has value only after you pay to fix the responsibility of the other, and is only worth anything to the extent you can collect that money from the former spouse.

If you are the defaulting party, and have reached the point of filing a bankruptcy, keep in mind that a Chapter 7 discharge will not discharge the obligation to your former spouse, only your contractual liability to the creditor (assuming that is dischargeable). So while filing a bankruptcy can protect you from a lawsuit from the creditor, if your former spouse has to pay, they can still pursue you post-discharge for their damages.

(A side note: A chapter 13 filing does discharge that “divorce debt” in most circumstances).

So as you plan your divorce, keep in mind the impact of the division of the debts: Whether you can afford your share, the likelihood of your former spouse filing a bankruptcy or defaulting on his obligations, and whether it makes more sense to file a joint Chapter 7 before you divorce, just to take the debts off the table.  These are good conversation topics for your divorce counsel and bankruptcy counsel to explore.