Divorce and Bankruptcy

The intersection between family law and bankruptcy is fairly complicated. If you’re faced with that situation, it definitely makes sense to retain a lawyer who is experienced in the area of bankruptcy. Your family law lawyer is normally not the best choice unless they have extensive bankruptcy experience.

What is a bankruptcy? Basically, when a person is unable to pay their debts as they become due, they can declare bankruptcy.

When a person declares bankruptcy, all of their non-exempt assets that is assets that are permitted to be seized are essentially transferred to a person known as the trustee in bankruptcy. The trustee in bankruptcy liquidates these assets and uses them to pay off the bankrupt’s creditors.

The payments to the creditors are done on a pro rata basis – that is, each creditor receives the same percentage of the money that is owed by the bankrupt for instance, all creditors may received 10 cents on the dollar.

As well, when a person declares bankruptcy, all legal and other proceedings to collect money from the bankrupt must stop (for instance, family law proceedings for a division of property).

In addition, there are tables, somewhat like the child support guidelines, that state how much a bankrupt must pay to the trustee each month based on the bankrupt’s income. These payment are used to pay the creditors as well.

After a period, normally 9 months if it’s a person’s first bankruptcy, the bankrupt can apply to the court for a discharge. This is normally granted on a person’s first bankruptcy if they have not done anything fraudulent, etc. However, a judge can put conditions on the discharge – for instance, a continued monthly payment to creditors. When a person is discharged, except for any conditions attached by a judge, the slate is wiped clean – any debts owed before then are no longer payable.

I wrote about the effect of bankruptcy and child support and spousal support here.

The effect of bankruptcy on property division is a bit more complicated.

If the bankruptcy occurs before you separate, it has no effect on your claim for a division of property. This is because your claim for a division of property (technically a claim for an equalization payment) only arises on the date of separation. Of course, if your spouse goes bankrupt just before you separate, your spouse’s net family property may be virtually nothing, which may well mean you’re the one who has to make an equalization payment.

Let’s turn to the case where your spouse declares bankruptcy after you separate – can you still get the equalization payment that was owing to you?

A claim for an equalization payment against your spouse puts makes you a creditor of your bankrupt spouse. There is no preferential treatment in bankruptcy for equalization claims. You have the same right to a recovery of your equalization payment as any other creditor does. So, if your spouse ends up paying creditors 10 cents on the dollar, you’ll receive 10 cents on the dollar of your equalization claim.

There are some wrinkles to this. First, if the equalization payment was the main debt your spouse had, and the bankruptcy looks like an attempt to avoid an equalization payment, the bankruptcy judge may not be too impressed. You could object to your spouse being discharged from bankruptcy. The judge may put conditions on the bankrupt’s discharge, such as continued monthly payments for a few months. Note that you would need to share these extra payments pro rata with all of your spouse’s other creditors.

A second wrinkle is that there are some assets that are subject to a family law claim, but are exempt assets in bankruptcy. Examples of this are a person’s pension or a LIRA. That is to say, if a person goes bankrupt, they don’t lose their pension. But as part of an equalization claim, the value of the person’s pension must be included in their net family property.

In a situation like this, you’d need to obtain an order from the bankruptcy court allowing you to proceed with your family law claim for an equalization payment, notwithstanding the bankruptcy. In other words, when a person goes bankrupt, legal proceedings against them for money are stopped, and you need permission to proceed with legal proceedings for an equalization claim. The bankruptcy court will normally grant permission to proceed with a family law claim in these circumstances.

You then need to go to family court and ask for an “if and when” division of the pension. Basically this means that if your spouse receives the pension, when they receive it, they must use part of it to pay your equalization claim. Obviously this is somewhat of a tenuous claim – you’ll need to wait many years and if your spouse dies before receiving the pension, you’ll get nothing. But it’s better than getting nothing to begin with.

You're Invited to Call or E-Mail!

If you are considering divorce in Ottawa or the surrounding area -- or have already made your decision -- you're invited to email or call us. We'll explain how you can protect your legal rights, reduce the expense of divorce, and protect your children from undue emotional stress. Click here to contact us.