Making Sense of Bankruptcy: How to Protect Your Co-Signer
The “co-debtor stay” gives you an extraordinary way to take care of debts that someone co-signed for you.
In our last blog post a couple days ago we explained the “automatic stay” by discussing the highlighted words of this sentence:
Filing a consumer bankruptcy case immediately stops and then prevents almost all actions by creditors against you personally or against your income and assets.
But beyond protecting you—the person filing the bankruptcy case—bankruptcy law goes a big step further by also protecting someone who co-signed a debt for you. That co-signer is protected in spite of not being directly involved in your bankruptcy case. It’s one thing to provide protection to the person filing bankruptcy, but quite extraordinary for protection to be extended to one who is not a party to the proceeding.
Here’s a one-sentence explanation of this concept:
The “co-debtor stay” enables a person filing a Chapter 13 case to immediately—then either temporarily or permanently—prevent a creditor from requiring a co-signer to pay a co-signed consumer debt.
Only Works in Chapter 13, Not Chapter 7
Filing a Chapter 7 “straight bankruptcy” case does not directly protect your co-signer. All that it might do is wipe out your other debts and thereby free up enough money so that you can afford to pay the co-signed debt, so that your co-signer isn’t forced to do so.
But if you file a Chapter 7 case the creditor can pursue the co-signer (to whatever extent the law allows). That usually means the creditor can demand that your co-signer pay the debt in full and can sue your co-signer in order to force payment.
In fact your filing of a Chapter 7 case itself can trigger a creditor to take action against your co-signer. After all your filing is an announcement to the creditor that you won’t be paying the debt any longer. So it has to look to your co-signer.
In contrast, filing a Chapter 13 “adjustment of debts” immediately prevents the creditor from taking ANY collection action against your co-signer because of the “co-debtor stay.” This also provides a way to permanently protect that co-signer if you wish to do so.
The Effect is Immediate…
Similar to the “automatic stay” which protects you and your assets at the moment your bankruptcy case is filed, the “co-debtor stay” protects your co-signer immediately, just as soon as your Chapter 13 case is filed.
The creditor can’t take any action to collect the debt. The very first section of Chapter 13 of the Bankruptcy Code says that:
a creditor may not act, or commence or continue any civil action, to collect all or any part of a consumer debt of the debtor from any individual that is liable on such debt with the debtor, or that secured such debt.
So the creditor can’t sue your co-signer, has to stop a lawsuit if one was already filed, and overall can’t “act… to collect all or any part” of a co-signed debt.
… But Could Be Only Temporary
This protection can be temporary for the following reasons:
- If your Chapter 13 case is dismissed (kicked out) because you did not follow-up on it appropriately (such as by making the agreed monthly plan payments), then the co-signer protection ends.
- If you decide to change your Chapter 13 case into a Chapter 7 one, the co-signer protection ends—again, the “co-debtor stay” only works in Chapter 13.
- If you complete your 3-to-5-year Chapter 13 case and still owe something on the co-signed debt, the “co-debtor stay” protection ends and the creditor can pursue your co-signer for the balance still owed.
- The creditor can ask—anytime during the Chapter 13 case—for “relief from the co-debtor stay,” in other words, for permission to pursue the co-signer in spite of your Chapter 13 filing. You can prevent the creditor from getting this permission by permanently protecting your co-signer, as we’ll explain in the next section.
How to Protect Your Co-Signer Permanently
If the creditor does ask for permission to pursue your co-signer, to succeed it must base its request on one of two grounds:
1. The creditor could argue that your co-signer received the benefit of the credit extended, not you. The “co-debtor stay” protects co-signers who helped out the person filing the Chapter 13 case, not the other way around.
That is, the creditor will not get “relief from the co-debtor stay” if your co-signer was the one helping you. For example, you needed a vehicle, couldn’t finance one without a co-signer, so your co-signer stepped up.
If instead you co-signed to help out the other person, and the creditor asks for permission to pursue that other person, the bankruptcy court will give that permission.
2. To whatever extent your Chapter 13 payment plan does not propose to pay the co-signed debt in full, the creditor can get permission to pursue your co-signer to that extent.
So, if your payment plan would pay nothing on the co-signed debt, the creditor could get permission to pursue your co-signer for the entire debt. Conversely, if your plan states that you are to pay the co-signed debt in full, the creditor could not get permission to pursue the co-signer for any of the debt.
So, the way to permanently prevent a creditor from pursuing your co-signer is 1) for the co-signing to have been done on your behalf instead of the other way around, and also 2) for you to pay the co-signed debt in full in your Chapter 13 case.
The good news is that most of the time you are allowed to pay a co-signed debt in full through your Chapter 13 payment plan while paying less, or sometimes even nothing, to most of your other debts. That is, in most parts of the country you can completely favor your co-signed creditor to the detriment of your other creditors.
As a result, your co-signer is immediately protected upon the filing of the Chapter 13 case, he or she is protected throughout the life of the Chapter 13 case, and when the case is over you’ve paid the debt in full so that the creditor has no further recourse against your co-signer.
This Protection is From Being Forced to Pay the Debt
Besides wanting to protect your co-signer from being pursued by the creditor for payment, you might also want protection for him or her from adverse credit reports for late payments on the co-signed debt. It is unclear whether the “co-debtor stay” would prevent that for your co-signer. There are arguments both ways—which are beyond the scope of this blog post—and depend on what part of the country you’re in. So you need to ask your local bankruptcy attorney about this credit record aspect.
Consumer Debts Only
As you may have noticed from the quote about the “co-debtor stay” from the Bankruptcy Code above, it applies only to consumer debts not business ones. A consumer debt is one “incurred by an individual primarily for a personal, family, or household purpose.”