Divorce & Bankruptcy in Arizona

In Most Cases, a Bankruptcy Should Precede the Divorce.  Debt relief in the context of a divorce involves dissolving community property ties and terminating contractual liabilities.   In most cases, it is better to file the bankruptcy prior to finalizing the divorce.  Filing the bankruptcy first will prevent the family court from entering orders that might be non-dischargeable later in a Chapter 7 bankruptcy.  (See § 523(a)(5) & (15)).  In addition, by filing a joint or separate bankruptcy prior to finalizing the divorce, the marital community receives a discharge, allocating debts during the property settlement is avoided, and if filing jointly, the debtors can save money on attorney fees.

Inversely, if a divorce is finalized prior to filing bankruptcy, ex-spouses cannot file jointly, and more importantly, assigned debts may become non-dischargeable in the context of a Chapter 7 bankruptcy proceeding.  Specifically, a Chapter 7 discharge does not eliminate obligations of a divorce decree or separation agreement.  A Chapter 13, however, can discharge some domestic support obligations.

Understanding Community Property

In Arizona, all property acquired by husband or wife during the marriage is presumed “community property” unless a spouse acquired the property via a gift, inheritance, or owned the property prior to entering the marriage (See A.R.S § 25-211).  Community property begins at marriage and terminates at either death or upon service of either the Petition for Divorce or Legal Separation.  In addition, each spouse has equal management, control and disposition rights over their community property and has equal power to bind the community”, i.e. incur debt on behalf of the marriage (See A.R.S. § 25-214).   Community property liability is also coupled with the dual contractual obligation if both husband and wife signed and incurred the debt.

During the divorce, the family law court has the authority to allocate community property and community debts among spouses (Cadwell v. Cadwell, 126 Ariz. 460 (1980) & A.R.S. § 25-318), however, this allocation does not bind 3rd party creditors.  Therefore, the divorce decree and allocation of debts therein, operates to determine future rights and obligations relative to each spouse.  A divorced spouse can sue an ex-spouse for payment on a community property debt that was not assigned in the property settlement or in the decree, or for reimbursement for payment of a debt that was assigned to the other spouse (Fisher v. Sommer, 160 Ariz. 530 (Ariz.App. 1997).
These obligations to each other in the context of the divorce decree can become “domestic support obligations” within the meaning of the bankruptcy code (See 11§ USC 101 (14 A)).  As such, the bankruptcy code limits the ability to discharge these debts.  Therefore, it is important to speak with a bankruptcy attorney prior to filing for divorce, if possible.

An Exception to Filing the Bankruptcy Prior to Divorce

If the marital community has non-exempt property, it may be beneficial to allocate this property strategically among the spouses, to enable one spouse to file a Chapter 7 bankruptcy without jeopardizing this property to the bankruptcy process. An alternative would be to have the family court enter a temporary order allocating assets, which could also protect non-exempt assets.