If you or your spouse is involved in bankruptcy proceedings prior to, or during your divorce there will be an effect on any settlement. This article explains what those effects are.
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Overview of Terms
Bankruptcy occurs when you become insolvent and are unable to pay off debts to one or more creditors. It can be entered into voluntarily or forced upon you due to a petition from a creditor you have been unable to pay.
It is not the only route available to an insolvent individual. A second option is an Individual Voluntary Agreement, or IVA.
Both IVAs and bankruptcy proceedings cause complications for financial divorce settlements.
Bankruptcy
An individual may become bankrupt if:
- They cannot pay what they owe and wish to declare themselves bankrupt
- They are forced into bankruptcy by creditors to whom they owe £5,000 or more
- They have broken the terms of an IVA
A person who is bankrupt must hand over all their assets to an appointed Trustee in Bankruptcy who will then deal with the sale of assets, paying expenses and distributing the balance to the creditors.
Individual Voluntary Agreement (IVA)
An insolvent individual may enter into an IVA with the agreement of 75% of their creditors and the help of an insolvency practitioner. Usually preferable to bankruptcy, an IVA gives the debtor an agreed timescale to repay the debts or a proportion of them without fear of further action.
Financial Orders
During matrimonial finance proceedings, the court will make financial orders dictating the division of the family’s financial assets, property and wealth. It is these financial orders that ultimately detail what funds go to each of the two parties.
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Does the timing of the insolvency matter in relation to divorce?
The short answer is yes, the order of insolvency proceedings can have a significant impact on the divorce settlement.
If insolvency occurred prior to applying for divorce
If all bankruptcy or IVA processes have been completed prior to a divorce starting, then there is no additional effect on the end agreement. A historical insolvency would typically not feature in the divorce process other than any wider impact the insolvency may have had on the personal funds either party would have otherwise split as part of the divorce.
Why the timing of the IVA matters
If one spouse is considering an IVA, then the size of the assets could determine the speed at which the other may want to start divorce proceedings.
When a division of assets has been agreed prior to the IVA but not yet part of a court order, then the solvent spouse could become a creditor to the insolvent spouse alongside any others that form the IVA. Depending on the terms of the subsequent IVA, the percentage of total assets received could be significantly lower than expected.
With no prior arrangement in place, the IVA must be satisfied before any additional funds are available to form part of the settlement.
Choosing when to put forward for a divorce can become important. If the insolvent spouse has enough assets to satisfy the IVA and enough will remain that a financial agreement after that point is favourable, then it is worth holding off the divorce until the IVA is in place. If, however, the total assets are small, then making a claim as a creditor early gives the solvent spouse an equal stake to the other creditors involved.
Does the timing of bankruptcy matter in relation to divorce?
Yes, similar to the timing of the IVA, the timing of a bankruptcy during divorce proceedings can influence the outcome.
If bankruptcy occurred prior to applying for divorce
Should the matrimonial court order be in place before any bankruptcy is filed, the decisions laid out by the court order would still stand and the Trustee in Bankruptcy would have no claim on the monies and assets that now belong to the solvent spouse – bankruptcy does not undermine a matrimonial finance order.
This is often the best solution, with the solvent spouse now separated entirely from the bankruptcy proceedings and any assets safe. The potential for abuse does exist, however, and a Trustee in Bankruptcy or creditor who believes that the divorce has been put in place purely to safeguard the family’s assets from being properly used to repay debt may petition the court to set the financial order aside. This prevents couples approaching bankruptcy from desperately filing for divorce to attempt to fraudulently protect their assets from creditors.
Outside of abuse, the protection of the financial order from subsequent bankruptcy exists to ensure an ex-spouse is not unfairly treated due to the other’s financial mismanagement.
What if bankruptcy occurs during divorce?
A bankruptcy petition that has been begun but not finalised as a bankruptcy order at the time of a matrimonial order being initiated can cause problems. In this instance, the matrimonial judge approving the order is restricted to agreements that serve the solvent spouse’s need and specialist custom drafting of an order may be required.
In most cases, it is easier to allow the bankruptcy order to be finalised before initiating a divorce.
What if bankruptcy occurs after divorce but before settlement?
A settlement order that occurs after a bankruptcy has been completed is restricted to any funds remaining after the Trustee in Bankruptcy has had the assets transferred – typically zero. In this case, the order becomes the province of the bankruptcy court and not the family court.
With both bankruptcy and IVAs, it is usually preferable for the solvent spouse to begin a matrimonial court order before the insolvency orders are initiated.
Summary: The timing of bankruptcy and divorce can have a significant affect on the outcome. Generally, it is beneficial to begin divorce proceedings before any insolvency process, though circumstances may dictate otherwise.
Dividing the family home – what happens to the house with bankruptcy?
One of the more common questions regarding divorce and bankruptcy is ‘will I lose my home?’. It is a fear shared by everyone involved.
The immediate answer is ‘no’. The more in-depth answer follows:
Is the family home considered an asset with regards to the bankruptcy?
If the insolvent spouse is an equal owner of the family house, then their half of the house equity becomes an asset that the Trustee in Bankruptcy will be looking to realise to pay off creditors. They can only do this if the house is sold.
If, however, the solvent spouse and any dependants are still living in the house, the Trustee in Bankruptcy is unlikely to force an immediate sale (and in the case of dependants, will be unable to).
The Trustee in Bankruptcy will do their best to negotiate an amicable agreement to release the funds, this could be through:
- selling the insolvent spouse’s share to the solvent spouse.
- selling the house with the solvent spouse’s agreement.
- forcing a house sale after an appropriate term to allow the solvent spouse to make new housing arrangements.
Typically, the Trustee in Bankruptcy will give a year for the solvent spouse and any dependants time to find new accommodation, and that period may be able to be extended through negotiation. Eventually, however, the house will have to be sold to release the cash tied up in the property.
What if the house is not shared equally between divorcing parties?
If the solvent spouse owns 100% of the property, then it falls outside of the assets taken by the Trustee in Bankruptcy. This situation may become more complicated if the insolvent partner is requesting a share of the house as part of the matrimonial financial orders, and it may be that a divorce prior to bankruptcy proceedings is consequently not in the solvent spouse’s interest.
When the ownership over the house is not an even 50/50 split, the Trustee in Bankruptcy will be looking to realise whatever assets the insolvent spouse owns and may seem to have a stronger case for an early sale (when that percentage is higher) or weaker case (when lower).
In all cases though, the Trustee is entitled to obtain the appropriate share of the house as part of the bankruptcy order, and when the sale of the house is the only way to do this, will eventually enforce that right.
What happens when the house is part of a property adjustment order in the divorce?
If the bankruptcy order is already in place, any assets that belonged to the insolvent spouse become the purview of the Trustee and are no longer considered owned by the insolvent individual. As such, they cannot form part of the matrimonial financial order. In real terms, this means that if the divorce is put in place after the bankruptcy, the solvent spouse will not be able to request any of the other share of the house as part of the settlement agreement.
When the divorce process occurs prior to the bankruptcy, the resulting share of the house as determined by the matrimonial financial order or property adjustment order will be set and only the equity from the share allocated to the insolvent spouse can become part of the overall assets controlled by the Trustee in Bankruptcy.
Will the house be sold for full market value?
While the Trustee in Bankruptcy is looking to obtain as much value from the property as possible, they will also be keen to make a relatively quick sale and so may be willing to accept a lower offer on the house in order to compete the sale.
When in the position of having to sell the home to release a share of assets to the Trustee in Bankruptcy, it may be prudent to begin the process immediately and remain in communication with the Trustee to realise the maximum possible value.
What happens to a joint mortgage with bankruptcy and divorce?
Mortgage is a secured debt, and as such is not part of the bankruptcy process. If the mortgage has not been paid, the lender may already have taken steps to recover the security (the home), completely separately to any divorce or bankruptcy proceedings.
Upon divorce, a joint mortgage can be moved over to one party. In this case the solvent spouse may approach the mortgage lender and show willingness to take on the home in full and make the mortgage payments alone. This may be the case if the matrimonial financial orders leave the solvent spouse with 100% of the property.
It is important to note that the Trustee in Bankruptcy is only interested in the equity from the home – the difference between the value of the property and the debt secured upon it. If the house has zero or negative equity, then the Trustee in Bankruptcy may wish to delay a sale until the situation changes.
Read our Divorce and Mortgages page for more information.
Summary: Eventually, the family home may need to be sold to release the share of equity to the Trustee in Bankruptcy, but that will not be immediate. The solvent spouse and any dependants will usually be given a year before a sale is enforced.
Is it possible to use bankruptcy for financial advantage?
Attempting to use bankruptcy as a method for avoiding legitimate payments or ‘getting out’ of divorce settlements is not likely to work.
When courts can (and will) annul a bankruptcy
If the court believes that bankruptcy proceedings were entered into in an attempt to avoid fulfilling a matrimonial financial order, they are within their power to annul the bankruptcy, setting aside the bankruptcy order for the purpose of maintaining the financial order.
This can occur if the non-bankrupt spouse makes a claim that the other party filed for bankruptcy as an ‘abuse of process’.
An annulment will only be undertaken if the court is satisfied that the grounds of the original bankruptcy order were not sufficient and that the expenses and debts of bankruptcy have been paid as dictated by the Insolvency Rules 1986.
How does bankruptcy affect child maintenance?
Child maintenance payments are excluded from any bankruptcy. This is also true for previously-owed child-support debt – going bankrupt does not ‘wipe out’ any owed child maintenance payments and they must still be upheld.
Who pays the trustee costs?
Trustee costs must be paid prior to any creditors receiving money from the assets of a bankrupt individual. For this reason, it is often beneficial to reach agreements with the Trustee sooner, rather than later.
Should the solvent spouse be one of the due creditors, then expediting any process with the Trustee in Bankruptcy will be paramount. For example, delaying the sale of a house could increase the Trustee’s expenses and any extra financial gain made in terms of the sale might be significantly impacted, even to the point of completely wiping out any benefit, due to the extra time and work put in by the Trustee.
Only once the Trustee has been paid in full are the remaining assets calculated for distribution between creditors.
Legal advice for bankruptcy and divorce
There are many pitfalls that can happen in the mix between insolvency and divorce. It is always better to employ the professional skills of an experienced family lawyer when navigating this complicated terrain.
Do you need help with your divorce?
Get in touch now with one of our panel of specialist local family solicitors.
The information on this website is to be considered a guide and is therefore not legal advice. You use this information with the understanding that Wiselaw does not accept liability for any direct or indirect losses as a result of anyone relying on or acting upon the information on this website. Whilst we endeavour to provide accurate information, Wiselaw does not accept liability for any errors or omissions on this website.
