Bankruptcy Could Affect Divorce Proceedings

Posted on in Divorce

bankruptcy, Wheaton divorce attorneysMany marriages fail due to financial stress. Even if there are other factors involved, if one or both spouses file for bankruptcy, that may complicate any pending divorce proceedings. The biggest impact, in many cases, stems from the fact that filing for bankruptcy in federal court automatically stays or suspends any pending judicial proceedings involving the debtor. This includes a divorce lawsuit that has already been filed in the Illinois courts.

Chapter 7 Bankruptcy

In a Chapter 7 bankruptcy, a debtor must turn all of his or her assets over to a court-appointed trustee. The trustee then liquidates the assets, subject to certain exemptions, and uses the proceeds to pay back the creditors as much as possible. Any exempt or remaining assets are then returned to the debtor, who receives a discharge from the bankruptcy court.

But what happens to marital assets that are divided during a divorce? For example, in a recent Illinois bankruptcy case, a Chapter 7 trustee sought to “avoid” or undo a transfer of a husband's share of his formal marital residence to his wife. The couple owned the house as “marital property,” which under Illinois law meant each spouse “has a species of common ownership” that “vests” once one spouse filed for divorce. Once the court divides the property and distributes it to one spouse, the other spouse's legal interest is “extinguished.”

Judge Rejects Bankruptcy Trustee's Efforts to Undo Divorce Settlement

In this case, the wife filed for divorce in October 2012. A few months later, the husband filed for Chapter 7 bankruptcy protection. This automatically stayed the divorce case for about two years. Once the bankruptcy court lifted its stay, the divorce court in Illinois proceeded to award sole ownership of the residence to the wife.

The Chapter 7 trustee challenged this order in bankruptcy court. The trustee argued the wife was required to file a formal lien on the property in order to enforce the divorce court's judgment. The bankruptcy judge–and later a U.S. district court judge–rejected this argument.

As the district judge explained, federal law treats the bankruptcy trustee as the equivalent of a “bona fide purchaser” of real property. This is a formal way of saying that a hypothetical person who wanted to buy the husband's 50 percent interest in the house has a legal right to notice of the wife's contingent claim on that interest. The trustee argued the wife never provided that notice by filing a formal lien.

The judge, however, said that was unnecessary. The trustee already had “constructive” notice of the wife's interest based on the fact the property was previously held as joint tenancy—which is a matter of public record—and the husband and wife had lived there together for many years. A “prudent buyer” would have inquired as to the wife's ownership interest in the property, regardless of whether she filed a lien.

Are You Facing Bankruptcy and Divorce?

This is the sort of highly technical legal issue that may arise when bankruptcy mixes with divorce. Even under the best of financial circumstances, divorce is usually a messy operation. That is why you need an experienced DuPage County family law attorney at your side. Contact one our three convenient locations to speak with a lawyer today.


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