Divorce And Bankruptcy

Divorce And Bankruptcy

Written by Corrina Murdoch
Fact-checked by Caitlin Wood
Last Updated July 20, 2021

When divorce and bankruptcy happen simultaneously, a difficult situation becomes even more challenging. While there is no magic solution to these issues — both representing endings — there are ways to make the process smoother. By consulting the appropriate professionals and making a plan, you can move forward in the best way possible. The first step is understanding how matters of divorce and bankruptcy co-relate, particularly as it applies to financial planning. 

How Does Bankruptcy Affect A Divorce?

The impact of bankruptcy on divorce depends on the state of the bankruptcy proceedings and the stage of the divorce. 

Before You Finalize The Divorce

Filing for bankruptcy prior to the finalization of your divorce, your assets move to the bankruptcy estate. Overseen by a Licensed Insolvency Trustee, the assets are not available for divvying up in a divorce. Regardless of how far along the divorce proceedings are, your assets go toward the bankruptcy estate, paying off your debts pursuant to the bankruptcy agreement. 

After You Finalize The Divorce

If a divorce is finalized prior to bankruptcy and the assets move to the control of the other divorcee, the assets are not available to creditors. The assets must have been transferred because of a Court Order or separation agreement. Provided these steps are taken in good faith, there is no way to apply these assets to what gets liquidated during the bankruptcy. 

Will Alimony And Child Support Be Discharged Through Bankruptcy? 

The goal of the court is to protect the interests of the children; and, as such, you cannot avoid child support or alimony as a result of bankruptcy. Per the Bankruptcy and Insolvency Act, in Canada, you continue to owe these amounts. If there is back pay owing, then the divorced spouse entitled to alimony can petition the court to receive that dividend from the bankruptcy estate. Referred to as preferred claims, any payments missed in the preceding 12 months will supersede the claims of any other creditors. 

In essence, if you owe $3,000 in alimony and $8,000 to credit card companies, yet your estate is worth only $10,000, the $3,000 will be paid out first. The rhetoric behind this legislation is that it is the onus of the bankrupt divorcee to meet familial responsibilities first — whether that is to an ex-spouse or a child. Section 178 (1)(b) of the act governing bankruptcy ensures this fact.  

How Does Your Child Support And Alimony Payments Affect Surplus Income?

Termed as deductible income, when you calculate any surplus income, it can reduce your payments during the period of bankruptcy. If based on your circumstances, you exceed the threshold for net income, you pay that to the estate. However, when you pay alimony or child support, this is deducted from your earnings. The calculations show your yearly net as less the maintenance payments, reducing your likelihood of having to make surplus income payments

How Does A Divorce Affect Joint Properties When Filing For Bankruptcy? 

Typically, married or common-law partners will co-own the family home. This is the common approach with residential properties since it awaits the complete distribution of assets. When bankruptcy enters the mix, matters change. Bankruptcies filed prior to the finalization of a divorce or separation agreement leave co-owned properties vulnerable to seizure. 

The level of severity of the results relies on the equity of the home. An ex-spouse, residing in the home, can cooperate with the Trustee to purchase the remaining equity. The amount goes toward the bankrupt party’s estate and leaves the ex-spouse as the sole owner of the property. 

Should the divorcing couple sell the home, the Trustee in charge of the bankruptcy estate will place a lien for the bankrupt’s ownership share. Sales proceeds go first to the mortgage discharge, next to the Trustee, and third to the ex-spouse. Because of this, many divorce arrangements dictate that the ex-spouse who will reside in the home is entitled to full ownership of the home.

Find out how to remove a name from a property deed here.  

How Will A Bankruptcy Affect Your Assets During A Divorce?

Assets impacted by the legal proceedings will differ based on which action began first. It results in either the bankruptcy or divorce superseding the other, determining what happens to the assets (or their equivalent value)

Before You Finalize The Divorce

Filing for bankruptcy before your divorce or separation is final leaves all assets up for grabs. Your assets are termed as a part of the bankruptcy estate. This means you must release them to the care of the Trustee. Some assets have exemption rules surrounding them, with most designed to enable the bankrupt individual to continue working. Examples include transportation, essential for employment, and other tools critical to life and livelihood. 

After You Finalize The Divorce

If you finalize your divorce or separation prior to filing for bankruptcy, any assets transferred to your ex-spouse are exempt from bankruptcy. The regulations surrounding bankruptcy use phrasing that dictates the asset transfer was done in good faith (ie: not to use the spouse as a shield for assets). Provided all the paperwork is in order and the divorce was completed prudently (with a proper legal professional), the assets are not at risk of liquidation. 

Be sure to explore all your options – check out the difference between debt consolidation and bankruptcy.

What Happens To Joint Debts If You File For Bankruptcy During A Divorce?

This is one of the most complicated parts of a divorce, challenges only furthered by bankruptcy. Generally, in a marriage, there are jointly-held or co-signed debts. The structure of such loans is that both parties are equally responsible for the full payment of the loan. In Canada, any debt held during the period of the marriage is the joint responsibility of both the married parties. Regardless of whether that credit card belonged to you or your ex-spouse, you are liable for the amount in full. 

When you file for bankruptcy during a divorce, creditors will seek out the joint account holder (the ex-spouse) for the amount. Bankruptcy filings do not eliminate the need for the debt to be repaid. It simply pivots the responsible party to the spouse not seeking bankruptcy. If you are married and co-own any property, whether explicitly stated in the loan agreement or deemed joint by virtue of marriage, bankruptcy will impact both parties. 

Keep in mind that if the divorce or separation is finalized, yet you stipulated in the agreement that you would pay debts evenly, you remain responsible until the amount is paid out completely. It is only the lender who can discharge your debt. It is considered best practice to get a letter of debt release from the lender, and to close the account. By using all available resources, including Licensed Insolvency Trustees and reputable lawyers, you can avoid some of the more severe financial repercussions of divorce. 

Final Notes

When all other options have been exhausted, bankruptcy and divorce may be the best path to take. The key is ensuring that you are proceeding with as much diligence as possible. Consult with professionals in their respective fields. Collaborative law is a newly emerging approach to marriage dissolution, assisting in managing costs and helping facilitate divorces that work for both parties. Licensed Insolvency Trustees are available to assist in debt management, and can assist you in securing a financial future, despite any financial setbacks. Do your research, take your time; and, with a bit of effort, the roadblocks of divorce and bankruptcy can make way to new paths. 

Rating of 5/5 based on 2 votes.

Corrina Murdoch has been a dedicated freelance writer and editor for several years. With an academic background in the sciences and a penchant for mathematics, she seeks to provide readers with accurate, reliable information on important topics. Working as a print journalist for several years, Corrina expanded her reach into the digital sphere to help more people gain insight into the realm of finances. When she's not writing, you can find Corrina swimming and spending time with family.

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