WHAT ARE THE SPECIAL CHALLENGES WITH CO-SIGNED DEBTS?
Co-signed debts present a number of issues if you are thinking about filing bankruptcy.
First, there are risks in paying co-signed debts (or paying money to a co-signer directly) during the months before you file bankruptcy. So be sure to tell your attorney about any such payments when you first meet with him or her. These are potential “preference payments,” which I’ve discussed in previous blog posts. Please see “Should I Pay Relatives Money I Owe Them Before Filing Bankruptcy?” and “What Can You Do If you Paid a Relative Money Before Filing for Bankruptcy?” for my earlier discussions about this.
Second, once you file bankruptcy you may well want to treat a co-signed debt differently than your other debts in order to protect your co-signer. You may want to pay the debt so that your co-signer wouldn’t be required to do so. You may even be tempted to exclude your co-signed debt from your bankruptcy case by not including it in the list of creditors you provide your attorney, in an attempt to “protect” your co-signer by hiding that you’re filing bankruptcy from him or her. You may feel embarrassed to admit that in spite of the co-signer’s earlier help you still ended up needing to file a bankruptcy.
Your options for dealing with co-signed debts is today’s topic.
WHY IS IT CRUCIAL TO TELL YOUR ATTORNEY ABOUT YOUR CO-SIGNED DEBT(S)?
There are two major reasons to be upfront with your attorney about all your debts, and especially any co-signed ones.
First, you are legally required to list all your debts when you file a bankruptcy case. There can be serious consequences to intentionally excluding a creditor or any other important information from your bankruptcy documents.
Second, there are usually sensible solutions to your concerns, which your attorney can only help you with if you tell him or her about those concerns. As you’ll see in this blog post, there are a variety of possible solutions to the challenges that can arise with co-signed debts.
HOW ARE CO-SIGNED DEBTS HANDLED UNDER CHAPTER 7 “STRAIGHT BANKRUPTCY”?
A Chapter 7 case generally takes only three or four months to complete, and usually results in each of your debts either being discharged (legally written off) or not. Most debts are discharged, while certain unusual ones, such as recent income taxes, are not.
Co-signed debts are unusual in that in addition to a legal obligation to pay the creditor, you may well also have a separate obligation to pay the co-signer to whatever extent you fail to pay the direct creditor and your co-signer has to do so. This is why it is necessary to include both the direct creditor and your co-signer in the list of creditors of your bankruptcy case.
But in spite of this please understand that after your Chapter 7 is completed you are allowed to pay any creditor you want to in spite of listing the creditor and discharging its debt. The Bankruptcy Code makes that clear: “Nothing . . . prevents a debtor from voluntarily repaying any debt.” Section 524 (f).
This of course assumes you want to pay your co-signed debt to avoid your co-signer from being required to do so. If you don’t want to pay it, and you don’t want to pay your co-signer if he or she has to pay it, you just discharge both obligations in your Chapter 7 case and you’re done with them both.
However, IF it IS important to you to protect your co-signer by paying off the co-signed debt, and if you are current or can quickly get current on that co-signed debt, AND if your situation is otherwise appropriate for Chapter 7, that can be the cleanest and simplest way to go.
But life isn’t always so straightforward.
WHAT IF YOU ARE NOT CURRENT ON THE CO-SIGNED DEBT, OR CAN’T AFFORD TO MAKE THE PAYMENTS?
If you’re not current on your co-signed debt payments, the creditor may already be contacting or even suing your co-signer to force him or her to pay the debt. You filing a Chapter 7 case will of itself not stop the creditor from taking whatever action the law allows it to take against your co-signer. But again, if getting rid of your other debts will allow you to catch up and then keep up on your payments, and that will get the creditor off your co-debtor’s back, then Chapter 7 may still be the best option.
But if you need to stop the creditor immediately from pursuing your co-signer, consider filing a Chapter 13 “adjustment of debts” instead. It provides an unusual measure of protection called the “co-debtor stay.” See Section 1301 of the Bankruptcy Code. This prevents the creditor from contacting, billing or suing your co-signer, within certain conditions. The co-debtor stay legally stops ongoing collection efforts against your co-signer if you’re behind on the debt at the time your bankruptcy case is filed.
If the co-signed debt is current, because either you or your co-signer have been making the payments, and you want to take responsibility for paying it but can’t afford the regular payments, the co-debtor stay can prevent any new collection actions against your co-signer for not being current on the debt after your bankruptcy case is filed.
WHAT ARE THE LIMITS OF THE CO-DEBTOR STAY?
In a nutshell, the co-debtor continues to protect a co-signer throughout a Chapter 13 case in the face of opposition from the creditor ONLY if the Chapter 13 Plan provides for full payment of the co-signed debt. The creditor would be able to get permission from the bankruptcy judge to collect from your co-signer whatever portion of the debt that the Plan is not providing for.
So the way to protect your co-signer in a Chapter 13 case is to have your payment Plan set up in such a way as to have your co-signed debt be paid in full before your case is finished (usually within 3 to 5 years). That debt does not need to be paid under the same payment terms as provided in your contract with the creditor, as long as the Plan provides for eventual payment in full, including interest, and you do indeed complete your Plan successfully, with full payoff of the co-signed debt.
BUT IF THE CO-SIGNED DEBT IS PAID SLOWER THAN THE CONTRACT PROVIDES FOR, WON’T THE LATE PAYMENTS HURT MY CO-SIGNER’S CREDIT RECORD?
That’s a good question.
Practically speaking your co-signer’s credit record might not matter so much if the debt is already way behind before your Chapter 13 case was filed. You may not have the luxury of caring much about your co-signer’s credit record when the more urgent concern is to avoid him or her being forced to pay the debt.
However, if the co-signed debt was current and there was no negative credit reporting before your Chapter 13 was filed, you may want to prevent any new negative reporting during the case as the debt is paid off.
One possible solution is to have your Chapter 13 Plan structured so that the co-signed debt is paid according to the contract terms. But usually that’s not so easy, both because of Chapter 13’s procedural delays and the pressures of other important creditors who may need to be paid even more urgently—for example, a vehicle loan arrearage paid to hold onto a vehicle.
IS IT LEGAL FOR A CO-SIGNED CREDITOR TO MAKE A NEGATIVE CREDIT REPORT ON YOUR CO-SIGNER?
If the co-signer and you are both legally liable on the debt, the creditor can certainly report that the debt is late in being paid if that’s the case. That’s true outside of bankruptcy and if you file a Chapter 7 case.
The question is whether that’s true if you file a Chapter 13 case, specifically whether the creditor’s issuance of a negative credit report is a violation of the co-debtor stay forbidding the creditor from acting “to collect all or any part of a consumer debt of a debtor from any individual that is liable on such debt with the debtor.”
On the one hand the creditor would be merely reporting what is after all true—that the payments are late on the co-signed debt. On the other hand this negative reporting, or the threat of it, could be construed as an indirect way to make the debtor or the co-signer pay the debt, which is exactly the kind of pressure the co-debtor stay was intended to alleviate.
Unfortunately, there is no simple answer to this, with the result depending on the facts of the case and the discretion of the judge before whom the matter is heard. So you need to talk with your attorney if this is a concern for you.
HOW CAN YOU PROTECT YOUR CO-SIGNER BY PAYING THE DEBT IN FULL IF YOU CAN’T AFFORD TO DO SO?
In most Chapter 13 cases most of your debts—the “general unsecured” ones—are not paid in full. In fact often these are paid only pennies on the dollar, and sometime even are paid nothing at all. The most important benefit of Chapter 13 as far as co-signed debts is concerned is that you are usually allowed to pay the co-signed debt in full while paying little or nothing to the rest of your “general unsecured” debts.
HOW IS IT THAT YOU ARE ALLOWED TO DISCRIMINATE IN FAVOR OF A CO-SIGNED DEBT TO THE DETRIMENT OF OTHER CREDITORS?
There IS an anti-discrimination principle in bankruptcy, and particularly in Chapter 13, that you can’t favor one debt over the other legally similar debts. The Bankruptcy Code explicitly says that a Chapter 13 Plan “may not discriminate unfairly against any class [of unsecured creditors].” See Section 1322(b)(2).
However, way back in 1984 that part of the Bankruptcy Code was amended to add the following: “however, such plan may treat claims for a consumer debt of the debtor if an individual [(a co-signer)] is liable on such consumer debt with the debtor differently than other unsecured claims.” This language has been interpreted, at least locally, to mean that in a Chapter 13 Plan consumer co-signed debts can be paid in full, including interest, even if that means there is not enough money to pay the other unsecured creditors “little or nothing.” See In re Renteria.
DOES IT MAKE A DIFFERENCE WHETHER THE CO-SIGNED DEBT ORIGINALLY BENEFITED THE PERSON FILING BANKRUPTCY INSTEAD OF THE CO-SIGNER?
To be clearer about this question, when two people are legally liable on a debt often that debt was clearly entered into for the benefit of only one of the two, such as an adult brother co-signing on a credit card for his sister so that she could qualify for the card. So if the sister filed a Chapter 13 case it’s clear she could pay that credit card debt in full in her Chapter 13 Plan to the detriment of her other creditors. But if instead the brother filed a Chapter 13 case, could his Plan pay that credit card debt in full and pay “little or nothing” to the rest of his unsecured creditors, even though he hadn’t financially benefited from that credit card debt?
This is an issue that the Renteria ruling cited immediately above touched on. I addressed that case, quite an interesting one, in my previous blog post.
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