It isn’t just marriage that can get you roped in to a bankruptcy case that isn’t your own.
Own community property and a bankruptcy filing by your spouse or your soon-to-be ex can drag you into a bankruptcy court.
But the issue is broader: joint ownership of any kind of asset in any state, community property or not, exposes you to a loss of control of your property if your co owner files bankruptcy.
The bankruptcy court has the power to force the sale your property or require you to buy out your co owner. On a timeline not of your choosing.
Co owners at risk
If your partner in a business or a piece of real property files bankruptcy, the partner’s interest may be sold for the benefit of your partner’s creditors.
And since the sale price of just your partner’s interest in the property would probably be less than the fraction of the partner’s ownership, the Bankruptcy Code gives the bankruptcy trustee the power to sell your interest too.
Now, you get your share of the proceeds of the sale. Your interest doesn’t go to your partner’s creditors.
But you do pay your share of the costs of the sale and you shoulder any tax consequences that the sale triggers.
Your right of first refusal
You also get the right of first refusal: you can match the price at which the trustee proposes to sell the property and prevent the sale.
While that allows you to keep your asset, the timing may not be convenient. Buying out the bankruptcy estate may not be feasible at this point in time.
The Bankruptcy Code requires that a trustee who wants to sell co owned property bring an adversary proceeding before the judge.
The trustee has to show that the harm to the creditors of your partner if the trustee couldn’t sell the entire property would be greater than the harm to you of the proposed sale.
In the typical investment scenario, the trustee wins that one.
I come back to my rule that any time you pool money with another person, you need to plan from the beginning how the partnership ends.
If you are the owner in financial trouble, you need to understand how your co owners are impacted by your bankruptcy filing.
If you are the financially healthy co owner swept into a bankruptcy, you need a plan for either funding a buy out, or a court fight on the trustee’s ability to sell.
Or you need to rustle up a compatible buyer for your partner’s interest.
Nothing is simple, these days.
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