Whenever I file a Chapter 13 on behalf of a client, I remind my client that five years is a long time, and that a lot can happen during the term of a Chapter 13. Marriage counselors reguarly opine that financial stress often leads to marital discord, so it should come as no surprise that the stresses inherent in a Chapter 13 will result in marital problems.
What should you do if your marriage begins to unravel during the course of your Chapter 13. There are obviously many scenarios that I could discuss, but I am going to start with a real life example that I am watching develop currently.
The case study I am presenting involves a Chapter 13 client who was married at the time we filed over two years ago. Because the debts at issue were hers alone, she filed individually. Over the course of the past two years, her marriage has floundered and she has been separated from her husband for well over 6 months. She advises me that there is no hope for rehabilitation.
My client has primary physical custody of her children, and she has moved into a rental home. Her estanged husband lives in the former marital domicile. As best I can tell, there is a small amount of equity in the home – perhaps $10,000 to $15,000.
My client is also struggling financially. Although she receives child support, she is having a difficult time making ends meet. Gas prices, of course, are through the roof, as are the costs of other essentials like food and clothing.
The only secured debt in our case was a vehicle loan, but now the vehicle is non-operational and she is prepared to surrender it. There is a small amount of outstanding tax debt and around $25,000 or unsecured debt.
If there was no divorce issue, this would clearly be a case that is appropriate for conversion to Chapter 7. My client’s income is below the median income for a 3 person household and all of her debts are now unsecured.
The problem, of course, has to do with the pending divorce issues. If my client was to convert to Chapter 7, it would be in her best interest – in a bankruptcy context – to surrender all interest in her house. She is not living there and it does not make any sense for her to reaffirm a financial obligation on someone else’s house. After all she has no control over whether her soon-to-be ex-husband will make payments regularly or even maintain insurance on the property. If the property insurance should lapse and the house burns down, my client could find herself with hundreds of thousands of dollars of liability, not to mention devastating derogatory marks on her credit.
From a divorce perspective, however, the decision is not so clear. Right now, the ex-husband is living in the house and presumably wants to stay there. If there was no bankruptcy complication, my client could use her title and equitable interest in the house as a negotiation point. Ever dollar that the ex-husband spends to pay down the mortgage is creating equity that my client may have a claim against. Arguably, my client could ask a divorce court judge to award her possession of the house, so as to provide a stable living environment for her kids. The estranged husband most likely does not want to live with the uncertainty. My client could bargain away her equitable interest in the house in exchange for a larger property settlement or perhaps for some other concession.
If my client was to convert to a Chapter 7 now and surrender all interest in her house, she would be giving up that leverage. In addition, the estranged husband could use the bankruptcy filing against my client – perhaps questionning her financial stability or arguing that his credit has been damaged if the mortgage lender forces him to refinance.
Everything else being equal, my advice to my client is to consult with her divorce lawyer as soon as possible and to get that process moving. The bankruptcy trustee and judge usually will not have a problem with a property transfer in a Chapter 13 that is pursuant to a divorce. If she is going to convert to Chapter 7 – and she really does need to do so – she should wait until her divorce case is more settled.
Ideally, she should not have waited to finalize the divorce, but she did. Now she may have to wait several months, but, in my view, this is her best course of action.