Creditor and Debtor Windfalls from Divorce

Abstract

At the end of a marriage, marital debt must be allocated. Under most marital property regimes, a divorce allocation does not preclude a creditor of the marital community from seeking satisfaction from either spouse, community creditors receive a potential windfall when a couple divorces. As a consequence, the divorce enables a community creditor to obtain satisfaction from assets that are separate property assets of a non-debt-incurring spouse, while these assets are unavailable to the creditor during marriage. The current California statutory regime explicitly offers the potential for this windfall whenever the non-debtor spouse is allocated all or a portion of a community debt at divorce, because debts allocated to a spouse at divorce can be satisfied with all of the assets controlled by that spouse, without the need for tracing. At the same time, under the current California statutory regime the creditor can be harmed by the divorce if the non-debtor spouse is not allocated any of a debt at divorce, because none of the assets taken by the non-debtor spouse are available to the creditor, even though the creditor would have had access to them during the marriage. Both currently-existing approaches are undesirable. Windfalls for creditors needlessly impose on non-debtor spouses at divorce, and windfalls for non-debtor spouses create incentives for couples to divorce to minimize the assets available to creditors, place huge pressure on allocation of debt between the spouses at divorce, and lead in the direction of turning every divorce in which there is unpaid community debt into a bankruptcy-style procedure in which the needs of the creditors influence the allocation of debts and assets.

A simple solution will eliminate these windfalls from divorces and avoid the incentives created by such windfalls. A post-marital debt structure that is the mirror image of typical premarital debt structures should either be read into current statutes, or enacted, to remove the windfalls. The result would entitle creditors to only those assets that would have been available had there been no divorce. While this will necessitate tracing each asset that a creditor seeks to obtain from a non-debtor spouse, and may raise some difficult untangling matters, such tracing is a familiar activity, already undertaken in creditor/debtor contexts in community debt/separate debt regimes whenever a creditor seeks contested assets against a married creditor. Requiring such tracing will not be overly cumbersome, and the approach avoids the far more encompassing problem of hurting non-debtor spouses at divorce or involving creditors in every divorce in which there is unpaid marital debt.

Keywords: marital debt, marital property,