Bankruptcy and Guaranteeing Debts in Colorado

October 26, 2010

By: David M. Serafin

As a Centennial bankruptcy attorney, I’ve found that many clients are justifiably concerned about what will happen to a family member or friend who guaranteed or co-signed on a debt that will now be discharged in chapter 7 or chapter 13. The result will typically depend upon which chapter is filed.

Despite being the quickest, simplest and easiest chapter of bankruptcy, chapter 7 is a poor option if you are concerned about leaving a family member or friend in Colorado on the hook for the debt you intend to discharge. Most unsecured debts can be discharged in chapter 7. Thus, a creditor will immediately turn to the guarantor or co-signer (who is not afforded the same automatic stay protections as the bankruptcy debtor) to pay the entire debt, which likely includes accumulated interest and late fees.

At the same time, if the client does not have any disposable income to pay into a chapter 13 plan and is otherwise eligible for chapter 7 relief, the decision as to which chapter to file under becomes more difficult. The client who files for chapter 7 can opt to sign a reaffirmation agreement with the particular creditor for which a co-signor exists but, as is always the danger with reaffirmation agreements, the client is entering into a post-bankruptcy petition obligation which cannot be discharged by the current bankruptcy (it can only be discharged in a separate, later bankruptcy action, hardly an optimal solution).

Chapter 13 is a preferable option for a client who intends to protect a co-debtor from responsibility for the debt. A 3 to 5 year payment plan can provide for the full repayment of the debt, without the co-signor being on the hook.

Chapter 13 also allows for co-signors to enjoy the same automatic stay provisions as the debtor. The strictly enforced automatic stay provisions prevent against any creditor initiated collection attempts against a co-signor so long as the debtor is making full plan payments to the chapter 13 trustee and will permanently exonerate the co-signor from liability on the debt so long as the debtor ultimately obtains a discharge after all plan payments are made (after 3-5 years).

However, exceptions permitting a creditor to pursue to co-signor and legally circumvent the bankruptcy automatic stay provisions include the following:

When the co-signor is the real party who benefits from having incurred the debt (e.g. the co-signor owns and lives in the house), or

If the bankruptcy court finds that continued enforcement of the automatic stay will irreparably harm creditor’s interest in the underlying property.

Even in chapter 13 matters, please note that the co-signor cannot benefit from the bankruptcy automatic stay when the debt was incurred primarily for business purposes or if the bankruptcy debtor’s case is dismissed or converted to chapter 7.

Finally, in situations where chapter 7 is the only feasible option, the client can always agree to pay back the co-signor for debts paid by the latter to a creditor.