Filing Bankruptcy During Divorce in New Jersey

Going through a divorce is challenging enough on its own, but when combined with overwhelming debt and the possibility of filing for bankruptcy, the situation becomes far more complicated. If you’re dealing with both divorce and financial hardship in New Jersey, it’s important to understand how these two legal processes affect each other. From automatic stays to the division of marital assets and debts, timing and planning play a crucial role. Filing bankruptcy during a divorce is not just a financial move; it can significantly influence your property rights, support obligations, and the overall resolution of your case.

Because New Jersey’s bankruptcy and family laws overlap in intricate ways, working with an experienced New Jersey bankruptcy attorney is essential. The right legal guidance can help you protect your interests, avoid costly missteps, and chart the most effective path forward. If you’re considering bankruptcy during your divorce, contact Straffi & Straffi Attorneys at Law at (732) 341-3800 to schedule a consultation. Our team is ready to help you move toward financial stability with confidence.

How a Bankruptcy Petition’s Automatic Stay Affects Your Divorce

The moment a bankruptcy petition is filed, a powerful legal injunction known as the automatic stay takes effect. This provision of the U.S. Bankruptcy Code immediately halts most creditor collection activities, including lawsuits, wage garnishments, and foreclosure proceedings. When someone is in the middle of a divorce, the automatic stay can significantly alter the course and timing of the family court process in New Jersey.

What Part of the Divorce is Frozen

The most significant consequence of the automatic stay in a New Jersey divorce is that it freezes the equitable distribution of marital property. Once bankruptcy is filed, all of the debtor’s assets, including their share of the marital estate, become part of what’s called the bankruptcy estate. This estate falls under the exclusive authority of the bankruptcy trustee and court.

Because of this, state family court judges are legally barred from dividing assets or debts while the stay is in effect. This means the court cannot:

• Issue orders regarding the sale of a marital home
• Divide bank or retirement accounts
• Allocate marital debt

Until the stay is lifted or the bankruptcy concludes, the financial components of the divorce are essentially paused.

What Divorce Proceedings Can Continue

While the automatic stay has a broad scope, it does not entirely halt all aspects of a divorce. The Bankruptcy Code makes explicit exceptions for key family law issues, allowing certain proceedings to move forward even after a bankruptcy is filed:

• Actions to establish or modify an order for alimony or child support, legally classified as “Domestic Support Obligations” (DSOs)
• Proceedings to determine child custody or visitation rights
• Cases involving domestic violence
• The legal dissolution of the marriage itself, meaning a judge can still issue a final divorce decree even if financial matters must wait

These exemptions ensure that important family protections and obligations are not delayed.

The Practical Reality and Lifting the Stay

Although some aspects of a divorce are allowed to continue, many New Jersey family court judges choose to pause the entire divorce case until the bankruptcy is resolved or the stay is formally lifted. This is largely because issues like alimony and child support are often tied to the financial picture established through property division. Proceeding with one part while the other is frozen can be inefficient or lead to inconsistent outcomes.

To move forward with equitable distribution during an active bankruptcy, one party must file a motion in bankruptcy court asking the judge to lift the stay. In New Jersey, these motions are often granted, as bankruptcy judges typically defer to the state family court’s experience in matrimonial matters. Still, this step adds legal complexity, time, and expense.

The type of bankruptcy filed also impacts the divorce timeline. As a result, choosing between Chapter 7 and Chapter 13 becomes not just a financial decision about debt relief but also a strategic consideration that affects the timing and cost of the divorce itself.

New Jersey Bankruptcy Lawyer Daniel Straffi, Jr.

Daniel Straffi, Jr., Esq.

Daniel Straffi, Jr., Esq. is a seasoned New Jersey bankruptcy lawyer with over two decades of legal experience. Admitted to practice in New Jersey, Pennsylvania, and the District Court of New Jersey since 2001, Mr. Straffi brings a deep understanding of financial relief strategies for individuals and businesses. After clerking for the Presiding Judge of Family Law in Mercer County, he worked in negligence defense before joining his family’s law firm, where he has since focused on bankruptcy, divorce, and criminal defense.

A graduate of Boston College and Rutgers-Camden School of Law, Mr. Straffi is known for his practical approach and client-centered service. He is an active member of the New Jersey and Ocean County Bar Associations, where he co-chairs the Bankruptcy Panel. As a certified mediator and early settlement panelist in Ocean County, he offers clients both skilled litigation and effective negotiation options for resolving financial hardship.

Timing Your Bankruptcy Filing

Beyond the immediate effects of the automatic stay, one of the most critical strategic decisions a divorcing couple must make is when to file for bankruptcy. There is no one-size-fits-all answer. The best timing depends on a couple’s financial situation, the structure and ownership of their debts, the value and nature of their assets, and, most importantly, their ability to cooperate. The main choice is whether to file before the divorce is finalized or to wait until after. Each route offers unique advantages and potential complications.

Filing for Bankruptcy Before Your Divorce is Final

For couples who can cooperate, filing a joint bankruptcy before the divorce is finalized can provide several key benefits. This approach addresses the debt burden upfront, setting the stage for a smoother and less contentious divorce.

The Strategic Advantages

• Cost Savings and Efficiency: A joint bankruptcy is more cost-effective than two separate individual filings after divorce. Couples save on court filing fees and attorney’s fees, and the process is handled through a single case rather than two.
• Enhanced Asset Protection: In New Jersey, married couples filing jointly can double many bankruptcy exemptions, depending on the type of bankruptcy. Exemptions protect certain property from being taken by the bankruptcy trustee. For example, the federal homestead exemption that shields equity in a primary residence can be doubled, allowing a couple to protect more of their home equity than either could alone.
• Simplified Divorce Negotiations: Discharging unsecured joint debts, such as credit cards or medical bills, prior to divorce can result in a cleaner financial slate. With fewer debts left to divide, equitable distribution becomes simpler, reducing the potential for conflict.

The Potential Pitfalls

• The Chapter 7 Means Test: Joint filers must pass the Chapter 7 means test, which compares their combined income to the state median. A couple’s joint income might be too high to qualify, which would push them into a Chapter 13 repayment plan. After the divorce, one or both spouses might qualify for Chapter 7 on an individual basis.
• The Requirement of Cooperation: Joint bankruptcy requires a high level of cooperation. Both spouses must provide full and honest financial disclosures and attend proceedings such as the meeting of creditors. In high-conflict situations, this kind of collaboration may not be realistic.
• Risk to Non-Exempt Assets: If the couple owns valuable assets that are not fully protected by exemptions, such as a vacation home or substantial investments, the Chapter 7 trustee can liquidate those assets to repay creditors. This can reduce the marital estate before the divorce court has a chance to divide it.

Category	Details	Impact
Cost Savings & Efficiency	Filing jointly avoids duplicate court and attorney fees; the process is streamlined into one case.	Reduces total legal expenses and simplifies the bankruptcy process.
Asset Protection	Joint filers in New Jersey can double bankruptcy exemptions, such as the federal homestead exemption for primary residence.	Protects more property, allowing a couple to retain greater equity in their assets.
Simplified Divorce	Discharging joint unsecured debts (e.g., credit cards, medical bills) leads to fewer financial disputes during divorce.	Eases negotiation and division of assets, reducing conflict and making divorce smoother.
Means Test Challenge	Joint income may exceed the Chapter 7 qualification threshold, requiring a switch to a Chapter 13 repayment plan.	Limits access to quick debt relief through Chapter 7.
Need for Cooperation	Both spouses must fully disclose finances and attend required proceedings like creditor meetings.	Difficult for high-conflict couples; lack of cooperation may derail the process.
Risk to Non-Exempt Assets	Valuable joint assets not fully covered by exemptions (e.g., vacation homes, large investments) can be liquidated by a trustee.	Reduces marital estate before the divorce court can equitably divide assets.

Filing for Bankruptcy After Your Divorce is Final

Choosing to file for bankruptcy after the divorce provides greater independence but introduces its own set of challenges, especially concerning joint debts.

The Strategic Advantages

• Individual Control: Each ex-spouse has full control over their bankruptcy process without needing cooperation from the other. This simplifies document collection and avoids joint appearances or decisions.
• Easier Chapter 7 Qualification: After the divorce, individuals often have a lower income that more easily qualifies for Chapter 7 under the means test, making it easier to eliminate debt quickly.
• Clarity of Obligations: A finalized divorce establishes clear responsibility for assets and debts. This allows for a more straightforward bankruptcy petition since each party knows what they own and what they owe.

The Potential Pitfalls

• The Joint Debt Trap: This is the most serious risk of filing for bankruptcy after divorce. Divorce decrees may assign responsibility for joint debts, but creditors are not bound by those orders. If one ex-spouse discharges their obligation in bankruptcy, the creditor can still pursue the other ex-spouse for the full balance. The non-filing spouse is then left with the debt and few options for recourse.
• Higher Costs: If both ex-spouses ultimately need bankruptcy relief, filing separately after divorce will be more expensive than a single joint case beforehand.
• Loss of Doubled Exemptions: A single filer cannot claim double exemptions. This may leave more property, especially home equity, exposed to liquidation than would have been the case in a joint filing.

The best way to avoid the joint debt trap is to deal with joint debts during the divorce itself. This may involve selling property to pay off liabilities, refinancing loans into one spouse’s name, or closing shared accounts. Relying on “hold harmless” clauses in divorce judgments is risky when bankruptcy is even a remote possibility.

Chapter 7 vs. Chapter 13 for Divorcing Individuals

The second critical decision for individuals facing both divorce and financial distress is which type of bankruptcy to file. The two most common forms of personal bankruptcy, Chapter 7 and Chapter 13, offer very different processes, timelines, and consequences. For someone going through a divorce, this choice is not just about debt relief. The choice of bankruptcy type to pursue can significantly impact the outcome of asset division, property settlement obligations, and future financial stability.

Chapter 7 (Liquidation)

Chapter 7 bankruptcy is often referred to as a “liquidation” bankruptcy because it involves a court-appointed trustee selling off the debtor’s non-exempt assets to repay creditors. In return, most unsecured debts such as credit cards, medical bills, and personal loans are discharged, giving the filer a clean slate.

How it Works: The process is relatively simple and fast. After filing, the debtor attends a meeting of creditors. If there are no objections or complications, the bankruptcy court typically issues a discharge order within a few months. In New Jersey, many filers retain all their property because their assets are protected by state or federal exemptions.

Timeline: The entire process generally takes between three to six months from the date of filing.

Who It’s For: Chapter 7 is ideal for individuals whose income falls below the state median and who pass the means test. It is best suited for those with limited non-exempt property and whose goal is to eliminate dischargeable debts as quickly and completely as possible.

Key Divorce Implication: Under Section 523(a)(15) of the Bankruptcy Code, debts owed to a current or former spouse that arise from a divorce—particularly those related to property settlements or equitable distribution—cannot be discharged in Chapter 7. For example, if a divorce judgment orders one spouse to make a payment to the other to equalize the division of marital assets, that debt will survive the bankruptcy and remain legally enforceable.

Chapter 13 (Reorganization)

Chapter 13 bankruptcy is a reorganization plan rather than a liquidation. Instead of selling assets, the debtor proposes a court-approved plan to repay all or a portion of their debts over three to five years. This plan is funded through a single monthly payment made to a Chapter 13 trustee, who distributes the funds to creditors according to the plan’s terms.

How it Works: The debtor retains all of their property, even if some of it is not protected by exemptions. Chapter 13 is commonly used to stop foreclosure and catch up on mortgage arrears, or for individuals whose income is too high to qualify for Chapter 7.

Timeline: The repayment plan must last a minimum of three years and can extend up to five years, depending on the filer’s income and financial situation.

Who It’s For: Chapter 13 is suitable for people with a steady income who either do not qualify for Chapter 7 or want to preserve valuable non-exempt assets. It also works well for those who need time to manage or restructure certain debts.

Key Divorce Implication: One of the most important distinctions of Chapter 13 is the “super-discharge” provision. This allows for the discharge of certain types of debt that are non-dischargeable in Chapter 7, including debts arising from property settlements and equitable distribution in divorce.

This creates a strategic dynamic in divorce planning. For example, a spouse who is ordered to make a large cash payment to their ex-spouse as part of a property settlement might be able to eliminate that obligation later by filing for Chapter 13. The receiving spouse’s main protection is to work with a knowledgeable attorney who ensures that any such payments are characterized in the divorce decree as “alimony” or “support.” These types of obligations are non-dischargeable in both Chapter 7 and Chapter 13.

What Can Go Wrong (and How to Prevent It)

Beyond the core strategy of deciding when and how to file for bankruptcy during a divorce, several advanced legal risks and technical pitfalls can significantly affect the outcome. These often-overlooked issues can derail carefully laid plans and result in financial harm long after the divorce is finalized. Understanding and planning for them is essential.

The Danger of Pre-Bankruptcy Transfers

It is common for divorcing couples to attempt informal settlements before filing for bankruptcy. For example, one spouse might transfer the title of a car or give a sum of money from a joint account with the understanding that this settles their share of the marital estate. Although this may seem fair and cooperative, it carries serious legal risks.

Bankruptcy trustees have the authority to reverse certain financial transactions made before the bankruptcy filing. This includes a “look-back” period of at least one year for transfers involving insiders, such as a current or former spouse. If the trustee determines that an asset was transferred for less than reasonably equivalent value or with the intent to hinder, delay, or defraud creditors, the transaction can be considered a fraudulent conveyance.

In such cases, the trustee may sue to recover the asset or its equivalent value for the benefit of creditors. The couple’s informal agreement or good intentions do not matter. A car, cash transfer, or other property settlement made prior to the bankruptcy can be legally unwound, disrupting what both spouses may have believed was a final and fair resolution.

The Indemnification Clause: A Shield Against “Phantom Debt”

One of the most serious risks following a divorce is the “phantom debt” problem. This occurs when one spouse discharges a joint debt through bankruptcy, leaving the creditor free to pursue the other spouse for the full remaining balance. A well-drafted indemnification clause in the divorce settlement can provide strong protection.

This clause establishes a new and independent legal obligation. If one spouse (Spouse A) is assigned a joint debt but fails to pay it for any reason, including bankruptcy, and the creditor then collects from the other spouse (Spouse B), the clause requires Spouse A to reimburse Spouse B for any amounts paid, including legal fees.

Courts often treat these indemnification obligations as being in the nature of support. This classification can make the obligation non-dischargeable in bankruptcy, similar to alimony or child support. A properly written indemnification clause can convert a third-party debt into a continuing personal obligation, providing one of the most effective ways to protect a client from future financial harm caused by a former spouse’s bankruptcy.

Tax Consequences

Bankruptcy and divorce both raise complicated tax issues that can become even more complex when they occur together. These consequences are frequently overlooked until it is too late.

While discharged debt is typically not considered taxable income, the transfer or sale of assets during divorce can create unexpected tax liabilities. For example, dividing retirement accounts without using a qualified domestic relations order (QDRO) may lead to penalties or taxable events. Selling the marital home could also trigger capital gains tax, depending on how and when the sale occurs.

In addition, bankruptcy-related asset liquidation or debt restructuring may affect tax deductions or credits. Consulting with professionals who understand both the legal and tax implications is essential. Without proper guidance, parties may find themselves facing costly tax bills that could have been avoided with advance planning.

Protecting Your Future During Divorce and Bankruptcy

Filing for bankruptcy during a divorce in New Jersey involves more than just filling out paperwork. It requires careful coordination, informed decision-making, and a clear understanding of how each legal process influences the other. Whether you’re trying to discharge overwhelming debt, protect key assets, or ensure a fair divorce settlement, the choices you make now will have lasting financial and legal consequences.

If you’re facing this challenging intersection of divorce and bankruptcy, don’t go it alone. The experienced team of New Jersey bankruptcy attorneys at Straffi & Straffi Attorneys at Law can guide you through every step with clarity and compassion. Call (732) 341-3800 today to schedule a confidential consultation and take the first step toward securing a stable financial future.

from Straffi & Straffi Attorneys at Law https://www.straffilaw.com/filing-bankruptcy-during-divorce-in-new-jersey/