Co-Signers and Bankruptcy
Before filing for consumer bankruptcy protection a debtor should always consider the ramifications: how his or her family will be affected, which debts are able to be discharged etc. If any debt is secured by a co-signer, filing for bankruptcy could place the co-signer in the position of being compelled to cover the debt.
The Automatic Stay
Regardless of whether a debtor is seeking a Chapter 7 discharge or Chapter 13 reorganization bankruptcy, an automatic stay goes into effect as soon as the petition is filed with the Court. The automatic stay has the effect of stopping collection efforts such as lawsuits and foreclosure proceedings. The stay of proceedings in a Chapter 7 bankruptcy, however, only protects the debtor, not a co-signer. As a result, creditors affected by the stay may immediately attempt to collect the debt from any co-signers. A debtor should always check with the creditor and review any contractual documents before filing for bankruptcy protection to determine whether the creditor can take steps to recover from the co-signer. This is particularly important if the debtor values the relationship with the co-signer.
Chapter 13 Bankruptcy Provides More Protection for Co-Signers Than Chapter 7 Bankruptcy
If the goal of a debtor is to protect a co-signer, a Chapter 13 bankruptcy is the best option. Unlike a Chapter 7 bankruptcy, a Chapter 13 bankruptcy filing stops proceedings against co-signers if the security is for consumer debt and the co-signer did not become obligated to repay the debt through the ordinary course of business. Arizona attorney, Christopher Ariano does a good job explaining the concept here:
The creation of a chapter 13 co-signer stay requires two important parameters be met :
First, it is important to understand that the cosigner stay created by a chapter 13 bankruptcy case applies only to certain types of debt. Specifically, the debt must be classified as a consumer debt and includes a number of common loan types including car payments, credit cards debt, and personal loans.
An important point to note is that tax debts and those for professional services are not considered consumer debts and therefore your cosigner will not receive the protection afforded by the cosigner stay. Whether or not your mortgage is considered a consumer debt depends on rules specific to the district in which you file.
Secondly, only individual cosigners qualify for protection under the chapter 13 bankruptcy stay. This excludes businesses or business entities from protection when they serve as a cosigner for chapter 13 debtors.
Under a Chapter 13 bankruptcy, the stay will remain in effect as long as the debtor complies with the bankruptcy plan and the creditor is receiving payments. The automatic stay terminates if the bankruptcy case is closed, dismissed or converted to another Chapter of the bankruptcy code. A creditor may also petition the court to lift the stay if it harms the creditor or if the repayment plan does not provide for full payment of the debt. Finally, if the debt is not fully repaid at the end of the Chapter 13 repayment plan, the co-signer will remain responsible for any outstanding balance. Consequently, before filing for bankruptcy protection, debtors with co-signers must consider more than just their own situation when determining whether filing for bankruptcy protection is in their best interest.
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