How Can You Protect Your Co-Signer in a Bankruptcy Case?

Law Office of Robert L. Firth Oct. 5, 2015

If you jointly owe a debt with someone, bankruptcy protects not only you but also your co-signer.

The last blog post was about how to protect yourself from a co-signed creditor and also from your co-signer. This one is about protecting the co-signer.

If your priority is to prevent your co-signer from being financially harmed, you have two options.

The Chapter 7 Option

You can commit to making your co-signer whole by paying him or her back whatever amount the creditor makes him or her pay on the co-signed debt. That could be impossible if you are under serious financial pressure from your other creditors. So to make it possible to pay back your co-signer, consider filing a Chapter 7 “straight bankruptcy” to discharge all or most of your other debts.

To be clear, the law clearly allows you to pay a debt that you have “discharged” (written off in bankruptcy) if you want, by paying the co-signed creditor or the co-signer if he or she has already paid off the debt at that point.

When filing that bankruptcy case you would make sure to list both the creditor AND your co-signer—for two reasons:

  • You are required under bankruptcy law to list all legal obligations. You clearly have a legal obligation to the creditor itself. And you likely have a legal obligation to your co-signer to pay him or her when he or she is forced to pay the co-signed creditor.

  • You must list both debts in your bankruptcy case if you want to legally discharge them both. Even if you intend to pay your co-signer, doing so when you have no legal obligation to do so is much more favorable to you. You can dictate the terms of repayment. And if your circumstances change, or if your relationship with your co-signer deteriorates, you can reduce the payment amounts or stop paying your co-signer altogether.

The Chapter 13 Option

You can often protect your co-signer much better under Chapter 13 “adjustment of debts.” If you file a Chapter 7 case, that does not stop the co-signed creditor from pursuing and suing your co-signer. In fact your very act of filing a Chapter 7 case could even trigger the creditor’s pursuit of your co-signer, because your filing cuts off the creditor’s ability to pursue you.

Filing a Chapter 13 case prevents this problem. Through the “co-debtor stay,” creditors may not pursue your co-signer except under certain circumstances. So you could either prevent your co-signer from being sued in the first place, or right after being sued you could prevent that lawsuit from going any further against the co-signer.

This “co-debtor stay” of Chapter 13 extends to “any individual that is liable on [a consumer] debt with the debtor.”

But this protection for your co-signer has significant limitations:

  • It only applies to consumer debts—co-signers on business debts, such as SBA loans, are not protected.

  • Taxes are not considered consumer debts for this purpose, so this does not work to protect people—ex-spouses or ex-business partners, for example—from the IRS or other taxing authorities.

  • The protection only lasts as long as your Chapter 13 case is active—whether your case is dismissed because of some problem or is completed in the usual three to five-years, after that to the extent the debt is still owed the creditor could then pursue your co-signer.

  • Even while your Chapter 13 case is active, the creditor could ask the court for permission to pursue your co-signer on either of two grounds:

    • if your co-signer received the benefit from the use of credit (such as the money lent), and not you

    • if the Chapter 13 plan does not pay the debt to the creditor in full

So Chapter 13 enables you to completely and permanently protect your co-signer on a consumer debt only if your Chapter 13 plan is designed to pay that creditor’s debt in full, and you in fact complete that plan accomplishing that pay-off. In most jurisdictions you are allowed to favor the co-signed debt over most of your other debts. That often makes Chapter 13 your best alternative if protecting your co-signer is very important to you.