A co-signer is defined as “an obligor—a person who becomes obligated, under a Commercial Paper, such as a promissory note or check—by signing the instrument in conjunction with the original obligor, thereby promising to pay it in full.” A co-signer may be either a co-debtor who is jointly liable for the debt or a surety who becomes liable for the debt only upon the default of the primary debtor. State law and the terms of the loan documents determine whether the co-signer is a co-debtor or surety. Regardless of whether the co-signer is a co-debtor or a surety, the creditor may attempt to collect the debt from the co-signer if the primary debtor fails to repay the loan.
What happens if the primary debtor files for bankruptcy? Can the creditor attempt to collect the debt from the co-signer? The answer to these questions depends upon the type of bankruptcy filed by the primary debtor.
Effect of a chapter 7 bankruptcy case filed by the primary debtor upon a co-signer
In a chapter 7 bankruptcy case, the bankruptcy court appoints a trustee to take possession of the debtor’s non-exempt assets. The bankruptcy trustee liquidates the debtor’s non-exempt assets for the benefit of the creditors and distributes the net proceeds, if any, to the creditors. The debtor is discharged from liability on the debt unless a timely objection to discharge is filed and sustained by the bankruptcy court.
A primary debtor’s chapter 7 bankruptcy case has no effect upon the legal obligations of a co-signer. The creditor may immediately pursue all collection remedies against the co-signer available under applicable law and the loan documents. In other words, the primary debtor’s chapter 7 bankruptcy filing does not provide any protections to a co-signer.
Effect of a primary debtor filing a chapter 12 or chapter 13 bankruptcy upon a co-signer
The result is different if the primary debtor files either a chapter 12 or chapter 13 bankruptcy. Chapter 12 (adjustment of debts for family farmers and fishermen with regular income) and chapter 13 (adjustment of debts for individuals with regular income) contain identical provisions imposing a co-debtor stay in favor of “any individual that is liable on such debt with the debtor.” The co-debtor stay becomes effective immediately upon the filing of the debtor’s bankruptcy case and continues in effect until the bankruptcy case is closed, dismissed, or converted to a chapter 7 or chapter 11 case. The co-debtor stay precludes the creditor from commencing or continuing any collection activities against the co-debtor, including, but not limited to, placing negative information in the co-debtor’s credit report, for as long as the co-debtor stay remains in effect. In other words, a co-signer may actually benefit from the primary debtor’s bankruptcy filing.
A creditor may ask the bankruptcy court to terminate the co-debtor stay under 3 circumstances. First, the bankruptcy court may terminate the co-debtor stay if the co-signer received the loan proceeds instead of the primary debtor. Second, the bankruptcy court may terminate the co-debtor stay if the debtor’s bankruptcy plan does not provide for payment of the creditor’s claim. Finally, the bankruptcy court may terminate the co-debtor stay if the “creditor’s interest would be irreparably harmed by continuation of such stay.” If the bankruptcy court terminates the co-debtor stay, then the creditor may pursue all of its available remedies against the co-signer.
In simple terms, as long as the primary debtor’s bankruptcy plan provides for payment of the creditor’s claim, a co-debtor (co-signer) will be protected from adverse consequences resulting from the primary debtor’s bankruptcy. The creditor may neither attempt to collect the debt from the co-signer nor report any negative information on the co-signer’s credit report without prior authorization from the bankruptcy court.
In summary, the effect of primary debtor’s bankruptcy filing upon a co-signer depends upon the type of bankruptcy case filed by the primary debtor. A primary debtor’s chapter 7 bankruptcy filing has no effect upon a co-signer’s legal obligations and the creditor may immediately pursue collection against the co-signer. A chapter 12 or chapter 13 bankruptcy filing creates a co-debtor stay which protects the co-signer from collection actions during the pendency of the chapter 12 or chapter 13 bankruptcy case. If you are a co-signer on a loan and you learn that the primary debtor intends to file for bankruptcy, it is in your best interest to try to persuade the primary debtor to file a chapter 13 bankruptcy rather than a chapter 7 bankruptcy.