Spouses don’t have to file bankruptcy together. Often there are strategic reasons for only one spouse in a community property state like California to file.
So, where does that leave the non-filing spouse when creditors come calling?
Community property in bankruptcy
Central to this discussion is the way the Bankruptcy Code treats community property. When someone with community property files bankruptcy, all of the marital community’s property becomes “property of the estate”.
Likewise, all creditors who could satisfy their claims from the community can file claims in the bankruptcy, regardless of which spouse incurred the debt. So, the issuer of the non filing spouse’s credit card can file a claim in the bankruptcy of the spouse who filed for relief.
The flip side of that coin is that the bankruptcy discharge granted to the filing spouse exonerates not only the filer’s personal liability on debts, but also the liability of any future-acquired community property for the debts of either spouse included in the bankruptcy.
As a result, the credit card company with the claim against the non-filer is barred from collecting its debt from the couple’s future wages, real property, or financial assets.
Pretty powerful, right?
Non-filer’s protection has limits
The automatic stay protects the debtor and the debtor’s property when a bankruptcy is filed. It stops any pending litigation or collection action against the debtor or the community property. Importantly, it does not stop a lawsuit against the non filing spouse or collection of the non-filer’s debts from any separate property that the non filing spouse owns.
Separate property is property that a person owned before marriage, or acquired during marriage by gift or inheritance. In California, just holding property in the name of one spouse does not make it separate property; in the absence of a pre nuptial agreement or a valid transmutation agreement, it’s still community property if acquired during marriage.
A spouse’s discharge in bankruptcy protects that person from dischargeable debts existing when the bankruptcy was filed. It’s personal to the filer. So creditors of the non-filing spouse remain free to sue the non-filer on debts incurred before the bankruptcy.
The tricky part is collecting on any judgment obtained. The liability of the couple’s community property was wiped out. Any creditor action that creates a judgment lien on the community property violates the discharge injunction. So, creditors who record a judgment lien as they would usually do, do so at their peril.
Importantly, the protection of the community property discharge ends when the community ends. Death of the spouse with the discharge or divorce terminates the community. The non-filer’s assets are once again separate property, liable for the non-filer’s debts.
Creditors don’t understand the community property discharge
While the legal protection of a spouse’s discharge is broad, most creditors and their collectors haven’t a clue. Typically, they are flabbergasted that a spouse’s bankruptcy filing affects the non filing spouse at all.
So, while the protection of the community property discharge is effective, the discharge doesn’t bring the same absolute right to be free of post-discharge collection efforts.
Limits on future filings
Even less well understood is the ability of creditors to challenge the right of the filing spouse to get a community property discharge. In fact, in 42 years of practice, I have never seen this happen, but the law exists, nonetheless.
Bankruptcy Code 524(b) provides that the community doesn’t get a discharge if the debtor’s spouse was denied a discharge in a bankruptcy case filed within 6 years of the present filing, or, would not be granted a discharge in a hypothetical case filed on the same date as the pending case.
However, to invoke this limitation, a creditor needs to file a challenge to the community property discharge in the same manner as if contesting the right of the debtor to a discharge.
Non-filer with non-dischargeable debts
The Bankruptcy Code has a similar procedure to limit the community property discharge when the non-filer has a community debt that would not be dischargeable in a case filed by the non-filer. A creditor with a potentially non-dischargeable claim against the non-filer must bring an adversary proceeding to establish that non-dischargeability in the bankruptcy case of the innocent spouse.
The time limit for bringing such challenges is short: typically 60 days after the first meeting of creditors. Again, it seems counter intuitive to sue in the innocent spouse’s case to establish the bad deeds of a spouse who isn’t in bankruptcy, but that’s the law.
A bankruptcy commentator famously said that the Devil Incarnate could get a bankruptcy discharge if he was married to Snow White. I will add to that “only if the creditors are asleep at the switch” in Snow White’s bankruptcy case.