Co-signed debts get tougher if your co-signer challenges the discharge of your obligation to him or her, or if the debt isn’t dischargeable.
Last week we discussed obligations on co-signed debts, both to the joint creditor and to your co-signer. In that discussion we assumed that both those obligations could be discharged (written off) in bankruptcy. But what if the co-signer challenges your ability to discharge the debt? And what if the underlying debt can’t be discharged, such as a recent income tax? We address these two situations today.
Co-Signer Challenging Discharge
If you file bankruptcy any creditor can challenge your ability to discharge a debt. But creditors’ grounds for successfully doing so are narrow, so such challenges are rather rare. The creditor essentially has to prove that you committed fraud in incurring the debt. You must have misrepresented your intentions at the time the obligation was created.
How would this happen with a co-signer? Assume that you needed a co-signer to incur a debt. As that time you intended to pay the debt so that the co-signer would not need to pay it. But because of unforeseen circumstances—for example, you lost a job or got sick—you couldn’t pay it. Your co-signer is upset that he or she has to pay it. He or she is unhappy that you are discharging your obligation to pay the debt through bankruptcy. He or she is even more unhappy that you are discharging your obligation to pay back him or her for paying off the debt. So he or she files an objection to this discharge of your obligation to him or her.
Would the Challenge Be Successful?
That objection by your co-signer to the discharge of your obligation to him or her would not likely get anywhere. In fact, your co-signer would likely by advised by a lawyer not to waste money on such a groundless objection. That’s because at the time you incurred the obligation you committed no fraud or misrepresentation. You intended to pay the underlying debt so that your co-signer would not need to.
Your co-signer would only have grounds for a successful objection to discharge if the facts were different. Assume that you lied to your co-signer at the time you persuaded him or her to co-sign the debt. You said you had no other debts when you had many debts. Or you said your income was very reliable when you knew that it was not. Under these circumstances your co-signer could allege that you misrepresented the facts to induce him or her to co-sign the debt. If the bankruptcy judge is persuaded that this is what happened, your obligation to your co-signer would not get discharged and you’d have to pay him or her whatever amount he or she paid on the underlying debt.
Nondischargeable Co-Signed Debts
Now on to the other scenario, in which the underlying debt itself can’t be discharged in bankruptcy. Recall the example of a recent income tax debt. Assume that you filed joint income tax returns with your spouse last year and you jointly owe the IRS $3,000. Now you’re getting divorced. This $3,000 joint debt is too recent to be able to discharge in bankruptcy. So you are both fully liable on that tax. In fact, even if the divorce court decrees that one spouse must pay that tax, the IRS still considers both fully liable.
Assume the divorce decree obligates you to pay this tax but you can’t afford to do so. You can’t discharge the tax obligation in bankruptcy. If you file a Chapter 7 “straight bankruptcy” case you also can’t discharge your separate obligation to your spouse created by the divorce decree for you to pay that tax instead of your spouse. So you need to make arrangements with the IRS to pay the tax. This would likely be in monthly installments, after discharging your other debts in your Chapter 7 case. You’d pay off the tax, and any additional interest and penalties.
This would be slightly different in a Chapter 13 “adjustment of debts” case. Again you can’t discharge the tax debt because it is too recent. However, under Chapter 13 you would be able to discharge your separate obligation to your spouse created by the divorce decree to pay all of the tax yourself. The practical difference? Under Chapter 13 you generally don’t have to pay ongoing interest and penalties. However, those would continue to accrue for your spouse, and he or she would likely be required to pay them. This would happen in spite of the divorce decree because bankruptcy law is stronger.
Possibly Nondischargeable Co-Signed Debts
The last scenario is a co-signed debt that could possibly be challenged as nondischargeable.
Assume you owe a business loan to a bank that you and a business partner co-signed. The business failed and you’re filing bankruptcy. Your now-former business partner has much more assets than you and is hoping to avoid filing. The bank is challenging your bankruptcy discharge of the business loan on the basis of some alleged misrepresentation. Assume also that your former partner has no grounds to challenge your separate obligation to him.
If you succeed in persuading the bankruptcy court that you made no misrepresentation in incurring the business loan, your obligation to the bank will be discharged, as will your separate obligation to your former partner. You will owe nothing to either the bank or your ex-partner.
If you do not succeed, the loan debt will not be discharged. You will continue owing the bank. If your former partner does not file bankruptcy or otherwise discharge the debt, you will both owe it. But assume also that you succeed in discharging your obligation to your former partner, since there made no misrepresentations to him or her. So your former partner cannot pursue you to pay the underlying debt. So if the bank forces him or her to pay the debt first, you won’t have to pay anything to the bank.
As you can see from these examples, protecting yourself when you owe co-signed debts can get complicated. Be sure to tell your bankruptcy lawyer about any possible joint obligations at your first meeting. It’s crucial to know what legal obligations you owe or do not owe to your co-signer(s). Then your bankruptcy lawyer can advise you how to best deal with them, together with your whole financial situation.