IF BANKRUPTCY IS A FEDERAL COURT PROCEDURE, WHY DOES CALIFORNIA LAW MATTER?
Even though the U.S. Constitution gives the federal government the power “to establish . . . uniform laws on the subject of bankruptcies throughout the United States” (Article 1, Section 8, Clause 4), state laws still have a tremendous role in how bankruptcy cases work. For example, state laws to a large degree govern the basic rights between debtors and creditors, and also the rights between spouses. As a result, it is state law that determines under what circumstances a creditor of one spouse can force payment of that debt from property owned by the other spouse, even when that other spouse was not directly involved in that debt.
WHAT’S A “COMMUNITY PROPERTY” STATE?
There are two basic systems of marital property ownership among the 50 states, the “equitable distribution” (also called “common law property”) system and the “community property” system. California is one of only 10 states which have a community property system of property laws.
The community property laws came to us from Mexico, since most of the community property states, including California, are on land that was once part of Mexico.
There are differences among the community property states, but they all follow the principle that property acquired during a marriage is generally considered to be equally owned by both spouses regardless who is on the property’s title.
WHY IS KNOWING WHAT EXACTLY IS YOUR PROPERTY IMPORTANT IN BANKRUPTCY?
Precisely knowing what is your property and what is your spouse’s is crucial because of what bankruptcy is all about. In bankruptcy you get a fresh financial start through a partial or full discharge (write-off) of your debts in return for turning over to your creditors whatever of your property that is not exempt (protected). If you are married and filing a bankruptcy without your spouse, the system needs to know what is yours and therefore is part of your bankruptcy case vs. what is your spouse’s and therefore not part of your case.
Most of the time you don’t lose any of your property that you want to keep because everything you own is exempt or protected in some other way. But when you are filing a bankruptcy without your spouse to get to that point you have to start by knowing what is yours and what is your spouse’s.
Note that in California the property exemptions are provided in state law—one of the biggest ways that state law matters in a bankruptcy filed in California. The California exemptions are relatively generous and flexible, among other things providing you an unusual choice between two entirely separate exemption systems. In general, one system favors those with a lot of equity in their home, while the other has a relatively large “wildcard” exemption, one that can be used for any category of property—helpful if you have an asset or two that do not fit within the provided categories.
HOW IS PROPERTY OWED BETWEEN SPOUSES IN THIS COMMUNITY PROPERTY STATE?
If you are married and live in California (or any other community property state—which include the adjacent states of Nevada and Arizona, but not Oregon):
- Your community property includes almost anything that either you or your spouse acquired during the marriage, including money earned by either of you, or any property purchased with such money, regardless in whose name any of this property is titled.
- Your separate property, and your spouse’s separate property, includes anything owed by either of you before the marriage and kept separate during the marriage, any gifts given to only one of you, and any inheritances either receives separately.
WHAT PROPERTY IS INCLUDED IF YOU FILE BANKRUPTCY WITHOUT YOUR SPOUSE?
All community property is included in your individual bankruptcy case, either though you share ownership of it with your spouse. Of course your separate property is also included in your individual bankruptcy case.
So you need to make sure that the property exemptions available to you are sufficient to cover all of your property, both separate and community.
However, as you’d expect, your spouse’s separate property is NOT included in your individual bankruptcy case. Your attorney may still advise you to list it in your bankruptcy papers—clearly indicating that it is your spouse’s separate property and not under the jurisdiction of the bankruptcy trustee. That way the trustee can quickly verify that it is indeed separate property and not make an issue of it.
SO WHEN SHOULD YOU FILE A BANKRUPTCY WITHOUT YOUR SPOUSE IN CALIFORNIA?
Be aware that there are many considerations other than community/separate property issues in answering this question. These include:
- the effect on both your debts and your spouse’s debts (an important topic I will cover separately in my next blog post)
- the effect on each person’s credit record, and on potential future joint credit purchases
- your costs in filing bankruptcy: the filing fee and attorney fees—a joint bankruptcy is usually much less expensive than two filed separately, especially if done at different times
- your convenience: going through two bankruptcies means virtually twice as much time and effort on your part in gathering paperwork, meeting with your attorney(s), attending the Meeting of Creditors, and everything else involved, again especially if the two cases are filed at different times
Beyond these, looking at this question from a community/separate property perspective, filing a separate bankruptcy for you may make sense if:
- your spouse has substantial separate property that he or she wants to avoid subjecting to the bankruptcy system
- your spouse may need to incur additional debts in the near future and they may need to file for bankruptcy to eliminate these debts
- as mentioned above, both your separate and community property are protected through the available state property exemptions
In other words, filing an individual bankruptcy may make sense if you have a good reason to do so—your spouse has separate property to protect—and you will not be hurt in doing so—all or most of your own separate property and your community property is protected through exemptions (or otherwise, such as through a Chapter 13 case).