One of the great mysteries of debtor/creditor law is the community property discharge in bankruptcy.
When only one spouse files bankruptcy in a community property state like California, the non filing spouse reaps bunches of benefits that creditors can’t imagine.
Benefits that aren’t explicitly described in books about bankruptcy or understood by creditors.
Those benefits start with the non filer’s wages being absolutely protected after bankruptcy from that person’s debts existing when the case was filed.
How can that be? frustrated creditors shriek.
It’s community property law, is the reply.
The phantom discharge works like this.
When one spouse files bankruptcy
File bankruptcy in a community property state and all of a couple’s community property becomes property of the estate. And, all of the creditors who have claims that can be collected from the community property are creditors in the bankruptcy case.
So, if Jane files bankruptcy, and her husband Joe does not join the case, Joe’s creditors who have a claim on the couple’s community property can participate in the case.
All creditors of either spouse can collect their claim from community property.
I say “can“, but that’s a stretch. Joe’s creditor doesn’t really get a choice about whether they are affected by Jane’s bankruptcy. If they get notice of the bankruptcy filing, they are bound by the outcome of the case.
At the end of Jane’s bankruptcy, her discharge eliminates all of her liability for her dischargeable debts. And the discharge eliminates any claim that listed creditors of Joe have to the couple’s community property.
Jane’s discharge protects not only the couple’s community property that exists when the bankruptcy is filed. It also protects any community property that they acquire any time in the future.
So, Joe’s creditors are really hamstrung. Their claims can only be collected in the future from Joe’s separate property.
Good magic if you are Joe; bad magic if you are Joe’s creditor.
What the discharge doesn’t do
While the community property discharge limits what Joe’s creditors can do, the discharge does not wipe out Joe’s personal liability for his debts.
He still owes the debts. Those debts can be collected from any separate property he has. That separate property might be
- assets he had before marriage;
- wealth he inherits; or
- gifts he receives.
If Joe doesn’t pay on the debts for which he is liable, his creditors can still sue him.
They can get a judgment. They can haul him in for a debtor’s examination.
They can report the debt as delinquent.
They just can’t levy, lien or garnish his wages or other assets he and Jane acquire as community property.
It can get messy.
Since it’s only the community property of the marriage that is protected by Jane’s discharge, the protection doesn’t survive the end of the marriage, either.
If Joe is widowed or divorces, his earnings become separate property.
A nasty quirk is that any community property that Joe acquires in a new marriage is liable for the debts he has that preexist the new relationship. Ouch.
Reasons not to file bankruptcy
Often, one spouse opts not to join in a bankruptcy because of employment concerns, either a position where bankruptcy seems inconsistent with the job description.
Or the debts in that spouse’s name are fewer.
Or they hope to hold on to a credit card that is important for work.
Or the couple hopes to use the non filer’s credit for some important purpose in the near term.
The household finances will be greatly improved by eliminating the creditors who can garnish the community property.
Each person is supposed to have their own file with the credit reporting agencies. Thus a bankruptcy of your spouse should only be noted on your credit report if you had joint debt.
The take-away here is that the post bankruptcy terrain for a married couple where only one files for bankruptcy is uneven.
How well the community property discharge works depends on what the non filer hoped to achieve by not filing. And how diligently the non filer asserts the benefits bestowed by the community property discharge.
More on community property
Image courtesy of wikimedia.