The Basics: Co-Signed Debts in Bankruptcy
Bankruptcy can protect you from your co-signer. Or instead can protect your co-signer from the creditor.
If you and someone else are both legally liable on a debt to a creditor, and all you care about is protecting yourself, and you can’t pay the debt, you have two distinct obligations to address—one to the creditor itself and one to the other signer.
The obligation to the creditor, based on your promise to pay the debt, most likely can be discharged (legally written off) by filing bankruptcy. The creditor could object to the discharge based on your alleged fraud or misrepresentation, but those objections are quite rare.
You likely have a separate obligation to the other person legally liable on the debt, depending on the circumstances. If the other person co-signed to enable you to get credit, then there could well be an understanding, or at least an inference, between the two of you that you would make the co-signer whole if you ever failed to pay the debt and the co-signer had to pay the creditor. If instead you co-signed to help the other person, and you got no benefit from the credit used, then you may not have any obligation to the other person.
But practically speaking, the creditor is very likely going to pursue both you and the other signer, and you need to protect yourself from both the creditor itself and any potential liability to the other person. A bankruptcy would likely discharge both obligations, protecting you from both.
So when you file bankruptcy, it’s crucial to list among your creditors both the creditor and the other person. Otherwise you could remain liable to that other person after your bankruptcy case is finished.
The other person could also object to the discharge of his or her claim against you, based on your fraud, misrepresentation, or similar bad behavior in the incurring of the debt. As stated above, these objections are rare. However, they ARE more often raised by former friends, ex-spouses, ex-business partners because they have a personal axe to grind. If you suspect that this other person may react this way, be sure to explain the situation thoroughly to your attorney, preferably when you first meet. He or she can access the situation, take any appropriate action, and won’t be blindsided.
Protecting Your Co-Signer
If in addition to protecting yourself one of your priorities is to prevent the other person from being financially harmed, there are two ways to go.
1. Chapter 7 “straight bankruptcy” could enable you to make that co-signer whole. That bankruptcy would discharge all or most of your other debts. Be sure to list both the original creditor and the co-signer on your bankruptcy schedules, because you are required by law to list all creditors, plus it is prudent to do so. Both obligations would be discharged (assuming no fraud-based objection by either), so you would have no legal obligation to pay either of them. But you are allowed to pay a discharged obligation if you want, so you would make non-binding arrangements to do that with your co-signer. Most likely the creditor would require the co-signer to pay the debt, so your arrangement may involve you making those payments instead on the co-signer’s behalf.
2. You can instead file a Chapter 13 “adjustment of debts” case to protect your co-signer from the creditor. This protection is provided by the “co-debtor stay,” only available under Chapter 13. It protects “any individual that is liable on [a consumer] debt with the debtor.” The co-debtor stay stops any attempts by the creditor to collect the debt through the co-signer. It applies only to consumer debts, does not apply to income taxes (for spouses or business partners), and lasts only as long as your Chapter 13 case is in effect (usually 3 to 5 years).
Furthermore, the creditor has the right to ask the court for permission to pursue your co-signer to any extent that 1) your co-signer (not you) received the benefit of the credit granted, or 2) your Chapter 13 plan does not provide for paying the debt to the creditor. So, assuming you received the benefit of the credit, to fully protect your co-signer your Chapter 13 plan must provide for paying that creditor’s debt in full. And to complete the protection, you must in fact so what the plan says, and pay the creditors’ debt off in full. In most part of the country, you are allowed under Chapter 13 to favor the co-signed debt over most of your other debts. That often makes Chapter 13 your best alternative if you want to protect your co-signer completely.