Chapter 13 Bankruptcy: The Co-Debtor Stay Advantage

In my experience teaching and practicing bankruptcy law, one point of confusion is the effect that filing for bankruptcy has on a co-debtor. While Chapter 7 leaves your co-signers exposed to creditor collection efforts, Chapter 13 offers better protection for co-debtors.

By Alexander Hernandez, J.D., Professor, and Author of Consumer Bankruptcy Law (Routledge).

Key Takeaways

• The Co-Debtor Stay: Chapter 13 prohibits creditors from collecting on consumer debts owed by co-signers while the bankruptcy case is pending.
• The Chapter 13 Plan: If the debt is paid in full through the Chapter 13 plan, the co-signer avoids a deficiency liability. If not, the creditor retains the right to sue the co-debtor for the outstanding balance once the bankruptcy is completed.
• Creditor Relief: Creditors can ask the court to lift the Co-Debtor Stay if they can prove the debt will not be paid in full or that they are suffering undue harm, thereby making the completion of the Chapter 13 plan essential to protecting the co-signer.

How the Automatic Stay Affects Co-Debtors

Unlike the standard Automatic Stay under §362, which is universal but limited in its protection of third parties, the Co-Debtor Stay under 11 U.S.C. §1301 is specifically designed to protect those who have debts in common with the filer.

When you file a Chapter 13 petition, the automatic stay stops any action to collect a consumer debt from a co-debtor or co-signer. This means that for the duration of the Chapter 13 bankruptcy, which lasts between 3 and 5 years, creditors are generally barred from contacting, suing, or garnishing a co-signer’s wages.

The Strategic Advantages of Chapter 13 Bankruptcy

The Co-Debtor Stay is not just a delay tactic, but also a strategy to keep assets when the debtor falls behind on payments, such as a car or mortgage. Chapter 13 bankruptcy allows the missed payments to be included in the plan.

Chapter 13 also allows for “cramdowns,” which reduce the loan balance to the fair market value of the vehicle, as well as “lien stripping,” which can reduce or eliminate second mortgages. Neither the cramdown nor lien stripping is permitted with a Chapter 7 filing.

The Limitations of Chapter 13 Bankruptcy and Co-Debtors

While co-debtors and co-signers are protected, that protection is not absolute. Co-signers can still be held liable for the debt. For example, if the Chapter 13 plan does not pay the creditor’s claim in full, the creditor may seek to lift the stay, which is requesting court permission to pursue the co-signer for the remaining unpaid portion of the debt.

Even if the creditor doesn’t take any action until after the Chapter 13 discharge has been approved, the creditor may sue the co-debtor for the entire remaining deficiency balance once the bankruptcy is completed or terminated.

The bankruptcy discharge does not eliminate the co-debtor’s contractual obligation. If the debt was not paid in full through the Chapter 13 plan, the creditor retains the legal right to sue the co-debtor for any remaining deficiency balance once the case is closed or terminated.

Consider this scenario:

A debtor files Chapter 13 with an auto loan balance of $25,000. The vehicle is sold at auction for $10,000, leaving a $15,000 deficiency. If the Chapter 13 plan only pays $5,000 toward that claim, a $10,000 balance remains.

Because the discharge doesn’t apply to the co-debtor, they remain fully liable for that $10,000. The creditor can pursue them for payment after the bankruptcy is completed. This forces the co-debtor to either reach a payment arrangement with the lender or file Chapter 7 or 13 bankruptcy.

The Professor’s Closing Thoughts

For debtors with co‑signers, Chapter 13 offers better protection than Chapter 7. The Co‑Debtor Stay could provide years of protection, but its effectiveness depends entirely on the debtor’s ability to complete the plan.

It is essential to understand that Chapter 13 does not rewrite the co‑debtor’s contract. While the bankruptcy delays enforcement, it does not eliminate liability. Once the case is completed or, with permission from the court, the creditor can pursue the co‑debtor for the unpaid balance.

For co-debtors, they have to be prepared for creditors looking to collect on the deficiency, whether it’s working out a payment arrangement or filing for Chapter 7 or 13.

Bankruptcy Code Statutory References

• 11 U.S.C. §362. Automatic stay.
• 11 U.S.C. §1301. Stay of action against codebtor.