If you file Chapter 13 bankruptcy and you have debt with a cosigner, your bankruptcy could potentially affect the cosigner.
(To learn how Chapter 13 bankruptcy works, what the repayment plan is, and how your debts are generally treated, see Chapter 13 bankruptcy.)
The Codebtor Stay
A person who files bankruptcy is called the debtor. Any person who is a cosigner on the debtor's loan is called a codebtor. When the debtor files bankruptcy, an automatic stay goes into effect that prevents all creditors from taking any action to collect the debts. (To learn more, see Bankruptcy's Automatic Stay.)
In a Chapter 13 bankruptcy, there is also a codebtor stay, which means the automatic stay also applies to any codebtors, including cosigners. While the codebtor stay is in place, creditors cannot collect against a cosigner. The codebtor stay continues until the bankruptcy case is over, unless the court lifts the stay at the creditor's request (which must be for cause -- see below).
To qualify for the codebtor stay, the cosigner must be an individual person, not a business entity, who did not cosign the debt as part of his or her ordinary course of business. The debt cosigned must be a consumer debt -- that is, a debt incurred primarily for personal or family purposes and not a business debt.
Example 1. Joe wants to take out a business loan, but his credit is too low, so his mother cosigns the loan for him. Six months later, Joe files Chapter 13 bankruptcy. The codebtor stay does not apply, because the debt is not consumer debt. Therefore, the lender can try to collect the debt from Joe's mother even though Joe is in bankruptcy.
Example 2. Amanda's father cosigned her first credit card. She used it to buy food, gas, clothing, and books for school. She files Chapter 13 bankruptcy. The codebtor stay applies to Amanda's father, because the debt is consumer debt, her father is an individual, and he did not cosign the loan for business reasons.
When the Creditor Tries to End the Codebtor Stay
If the codebtor stay does apply, the creditor can ask the court to lift the stay in certain situations. The creditor can file a motion with the court to lift the stay, and the debtor and codebtor will be permitted to respond. The creditor can ask the court to lift the codebtor stay if:
- the cosigner received the benefit of the debt instead of the debtor
- the Chapter 13 bankruptcy repayment plan does not provide for repayment of the debt, or
- the creditor's interests would be harmed beyond repair if the stay is in place.
Example 1. Dan takes out a car loan and his brother Ken cosigns on the loan. Ken drives the car, not Dan. The lender will file a motion to lift the codebtor stay to collect against Ken, since he received the property the loan was used to purchase.
Example 2. As in the previous scenario, Dan takes out a car loan, and his brother Ken cosigns the loan. Later, Dan files Chapter 13 bankruptcy. Dan's Chapter 13 plan does not propose to repay the car loan. The creditor can lift the codebtor stay.
Example 3. Again, Dan takes out a car loan and his brother Ken cosigns on the loan. Dan files Chapter 13, but six months into his plan, he stops making his payments, and the creditor is not getting paid. The car is rapidly depreciating in value. The creditor can file a motion to lift the codebtor stay to protect its interest in the car.
After the Bankruptcy
Once the bankruptcy is over, the codebtor stay is lifted. If a debt is not paid in full during the Chapter 13 case and is not discharged, the creditor can collect on the debt from the cosigner.
Example 1. Tom had a student loan that his father cosigned. Tom successfully completed a Chapter 13 bankruptcy and received a discharge; however, he was not able to discharge his student loan because he could not prove hardship. After the bankruptcy is closed, Tom and his father are both responsible for the remaining balance of the student loan.
Example 2. Jane filed Chapter 13 bankruptcy and was paying for her car through the plan. Her friend Donna is a cosigner on the loan. After paying into her plan for two years, Jane decides she no longer wants to be in a Chapter 13 and voluntarily dismisses her case. Once the case is closed, the codebtor stay is lifted and both Jane and Donna are responsible on the remaining balance of the car loan.
(To learn more about how debts are treated in Chapter 13 bankruptcy, see the articles in Your Debts in Chapter 13 Bankruptcy.)