I have already written about discharging student loans in bankruptcy. As I discussed in that previous blog post, although under special circumstances it is possible to discharge them, it is devilishly hard.
I recently came across an interesting twist on student loans in the bankruptcy context that I thought might interest you. The setting: A debtor wants to file for Chapter 7 bankruptcy protection. The nonfiling spouse died prior to the bankruptcy filing, and left a large student loan debt, for which the debtor did not cosign. What happens to the student debt? What happens to the deceased spouse’s other debts? Can the creditors attach heaven’s streets of gold to satisfy the debts?
I. Community Property/Community Debt
If you live in a community property state such as California, you can have some liability for your spouse’s debts. Why?
A. Dividing The Marital Assets
When a couple gets married in a community property state, all of the assets are divided into three categories: The husband’s separate property, the wife’s separate property, and the community property. How is this done? In the absence of a prenuptial agreement, community property consists of all assets except those assets with which a spouse enters the marriage, those assets a spouse inherits, and the offspring of such assets. See Cal. Fam. Code § 770. A moment’s thought reveals that community property must include post-wedding day wages, and anything purchased with those wages, because the wage earner didn’t enter the marriage with the wages or the stuff bought with the wages, and didn’t inherit them.
By default then, a spouse’s separate property is comprised of those assets that that spouse enters the marriage with, anything that spouse inherits, and the offspring of those assets.
Why do we care about this asset taxonomy? There are two contexts in which this breakdown is important.
B. Dividing The Assets In Divorce
The first context is very sad: The couple is going their separate ways. One step in the dissolution process is asset division. The husband gets his separate property, the wife gets her separate property, and the community property is divided in half, with each spouse getting one of the halves. The divvying up of the community property may be very contentious, with fights over which things really are community property and which things are separate property.
As a result, there is usually some (potentially acrimonious) horse-trading because, for example, unless a spouse is psychotic (and no, I’m not calling your dog a liar), no one will take a chain saw to the house. Thus, there may be some sort of equalization payment ― either in a lump sum, or in a payment stream ― to compensate a spouse for the loss of half the house. The take-away here is that in this context community property is thought of as a 50-50 proposition.
C. Dealing With Third-Party Creditors
In the second context the treatment of community property is quite different; that is in dealing with third-part creditors.
Suppose the husband (“H”) incurs a debt to ABC Bank, without involving his wife (“W”). In fact, W knows nothing about the debt. H stops paying. What can ABC Bank do?
I think we can all agree that ABC Bank can go after H’s separate property because that’s his, and if the couple were to part ways, he would keep it. And I think we can also agree that ABC Bank cannot touch W’s separate property because she had nothing to do with the transaction. What about the community property?
At first blush you might think that ABC Bank can go after 50% of the community property because H would get it in a divorce. But what portion of the community property belongs to H? After all, if the couple were to split, they might have a dickens of a time figuring out which spouse gets what. To force ABC Bank to have to make that determination would be unduly burdensome. Therefore, the law resolves this by letting ABC Bank go after all of the community property.
As a result, the term “community debt” is sometimes used to describe the debt of one spouse because the community property is liable for it. However, not all practitioners are comfortable with the slightly misleading quality of the term because it suggests that both spouses are equally liable, when one spouse’s separate property may not be liable for the debt.
D. Community Property/Community Debt In Bankruptcy
Based on the above-discussion you can see why, if only one spouse were to file for bankruptcy protection, that filing spouse would still have to list all of the community property ― including the nonfiler’s wages ― as it is liable for the filer’s debts. The filer would also have to list all the nonfiler’s debts since the community property is liable for those debts:
Except as otherwise expressly provided by statute, the community estate is liable for a debt incurred by either spouse before or during marriage, regardless of which spouse has the management and control of the property and regardless of whether one or both spouses are parties to the debt or to a judgment for the debt.
II. A Spouse Is A Nonfiler By Reason Of Death
What happens if a spouse is a nonfiler because that spouse died prepetition? Does it matter if the body’s still warm? Is the concept of community property even meaningful? What happens to the nonfiler’s debts?
The answers to these questions are much more complicated than I can do justice to in this single post. The gist is this: When someone dies, an estate is created, which consists of all assets that the person owned or had an interest in. Then a process called probate is used to resolve questions of distribution of the assets. In probate the deceased’s creditors get first crack at the assets. Once they’re paid in full, the terms of the will control. If there is no will, then a fairly complicated hierarchy of distribution controls.
If the surviving spouse files for bankruptcy, then as a general rule that person must list the deceased’s debts in the bankruptcy. But does that include the deceased’s student loan debt?
III. Death, Taxes, But Not Student Loans
According to Jackie Russell:
Although used by Mark Twain, the quotation that, “The only two certainties in life are death and taxes,” actually originated in a 1789 letter from Benjamin Franklin to Jean-Baptiste Leroy.
What about student loan repayment? If the debtor dies, Congress says that the debt repayment isn’t certain anymore:
If a student borrower who has received a loan described in subparagraph (A) or (B) of section 1078(a)(1) of this title dies . . . then the Secretary shall discharge the borrower’s liability on the loan by repaying the amount owed on the loan.
The loans described in 20 U.S.C. § 1078(a)(1) are the usual federally insured student loans.
The good news is: If you kill your spouse, you won’t be liable for your spouse’s student loans. That should give you some comfort as the lethal injection is administered.