If you can’t protect your co-signer through Chapter 7, Chapter 13 provides a strong and creative solution.
The last blog post explained how in very limited circumstances you could use a Chapter 7 “straight bankruptcy” to protect a co-signer from being harmed by your discharge (legal write-off) of your joint debt. But a Chapter 13 “adjustment of debts” is more often the more practical solution because it covers much broader circumstances.
The “Co-Debtor Stay”
Immediately upon the filing of your Chapter 13 case, not only are you protected from your creditors through the “automatic stay,” so is “any individual that is liable on [a consumer] debt with” you—your co-debtor.
The co-debtor stay automatically prohibits any act or civil action to collect “all or any part of a consumer debt” from such another individual. Your co-debtor or co-signer is immediately protected from the creditor along with you.
The Purpose of the Co-Debtor Stay
Importantly, this protection is actually intended primarily to protect you as the principal debtor on the debt, not so much to protect the co-signer. Its purpose is to insulate you from the indirect pressures exerted by creditors on co-signers such as friends and relatives. As you will see by the conditions on the co-debtor stay, it only delays collection of the debt, although in a way that can be quite beneficial for you and your co-signer.
A creditor can get permission to pursue the co-signer by getting “relief from the co-debtor stay” from the bankruptcy court, if it chooses to, in the following two circumstances:
1. If you—the person filing the Chapter 13 case—did not get the benefit of the credit incurred from the co-signed debt, but rather your co-signer did.
Remember that the co-debtor stay is designed primarily to protect you from pressure exerted on you by the creditor through your co-signer. If the co-signer received the benefit of the credit (either the cash borrowed or the item(s) purchased), he or she would have no reason to be pressuring you to pay it. So it makes no sense to shield the co-signer through your Chapter 13 case if you didn’t receive the benefit of the benefit of the debt.
2. Your Chapter 13 plan is not proposing to pay the co-signed debt in full.
To whatever extent it is not, the creditor can pursue the co-signer. This is consistent with the fact that the co-debtor stay merely delays collection of the debt, while protecting the co-signer in the meantime.
Note that in most areas of the country you can favor a co-signed debt in a Chapter 13 plan by paying it in full while your other unsecured creditors receive much less, or in some jurisdictions even nothing at all. That makes paying a co-signed debt in full much easier.
Let’s illustrate using a version of the example used in the last blog post (about protecting co-signers through Chapter 7). In it Zack took out a $7,500 business loan from his local bank, with his father very reluctantly co-signing it. Zack’s business eventually failed, leaving him owing about $100,000 in other debts, including about $15,000 consisting of the last three years of income taxes. The co-signed business loan now has a balance of $4,600, and has not been paid for a year.
Zack’s attorney advises him that a Chapter 13 case is the best way for him to deal with his income tax debts, all of which are too recent to discharge in a Chapter 7 case. If Zack filed a Chapter 7 case to write off the $85,000 in debts that could be written off, he would absolutely not be able to bring the business loan current and maintain payments on it considering how much he would have to be paying to the IRS.
So Zack files a Chapter 13 case, with his proposed payment plan designating the income taxes and co-signed debt to be paid in full, while the remaining $85,000 in debts of his closed business are to be paid nothing. After the bankruptcy court “confirms” this plan, Zack pays $420 per month for 5 years. This pays off all of his taxes, without any further interest and penalties, and pays the entire co-signed business loan, while protecting his father from any collections on that loan throughout the 5 years.