One of the most beneficial features of any bankruptcy filing is the automatic stay. The automatic stay acts as a bankruptcy restraining order against creditors and prohibits almost all creditor actions to collect on a debt. As its name implies, the automatic stay goes into effect immediately when the bankruptcy case is filed with the Court.
However, the automatic stay generally protects only the person who filed for bankruptcy protection. The protection does not extend to other people who are also liable for a debt, such a co-signers or guarantors. The co-debtor may be a spouse, another family member, a friend, or a business partner. In most cases, the creditor can proceed against the co-debtor for collection of the debt. For example, if a married couple is jointly liable for a debt, and the husband files bankruptcy, but the wife does not, then the creditor could still pursue the wife for the debt.
A creditor’s pursuit of co-debtors puts indirect pressure on the person who has filed bankruptcy. That pressure may cause the person to repay debts that would otherwise be discharged in bankruptcy. It may ultimately defeat the purpose of the bankruptcy filing or limit the value of the bankruptcy filing.
To combat this issue, the Congress created the Co-Debtor Stay. The Co-Debtor stay extends the protections of automatic stay to co-debtors in certain circumstances, even if the co-debtor did not file bankruptcy. The Co-Debtor Stay prevents creditors from pursuing the Co-Debtor for the duration of the bankruptcy proceeding.
Here are some facts you should know about the Co-Debtor Stay:
- The Co-Debtor Stay does not apply to Chapter 7 Bankruptcy.
The Co-Debtor Stay is provided by 11 U.S.C. §1301 and is applicable when the Debtor files a Chapter 13 bankruptcy. It does not exist in Chapter 7 Bankruptcy. As discussed below, the Co-Debtor Stay also applies in Chapter 12 Bankruptcy and, in some cases, in Chapter 11 Bankruptcy.
- The Co-Debtor Stay only applies to “Consumer Debts”.
“Consumer Debt” is defined as a debt that is incurred “primarily for a personal, family, or household purpose.” Fortunately, that definition is broad enough to cover almost all of the debts that typically appear in a bankruptcy filing, including credit cards, medical bills, personal loans, vehicle loans, and mortgages. However, it does not include tax debts, debts incurred with a profit-making motive (such as business debts), or debts related to the dishonor of a negotiable instrument (such as “bad check” debts).
- The Co-Debtor Stay only protects co-debtors who are individuals, not business entities.
The law specifically refers to co-debtors who are “individuals,” meaning people. So, if the co-debtor is a business entity, such as a corporation or LLC, the Co-Debtor Stay does not protect the co-debtor. This can be important where an individual business owner is filing Chapter 13 bankruptcy, but their business is not filing for bankruptcy protection.
- The Co-Debtor’s liability for the debt is not discharged
The Co-Debtor’s obligation to pay the creditor are not altered or discharged by the Co-Debtor Stay. The Co-Debtor stay only postpones the creditor’s collection actions until after the bankruptcy is over. The Co-Debtor is protected during the life of the bankruptcy, but once the bankruptcy is over, the co-debtor remains liable for the unpaid debt. For example, if the bankruptcy payment plan pays 25% of the debt, the co-debtor remains liable for the other 75% of the debt. For this reason, some bankruptcy payment plans provide for payment of joint debts in full in order to protect the co-debtor after the bankruptcy case is over.
- The Co-Debtor Stay may be modified or terminated by the Bankruptcy Court.
Creditors may apply to the Bankruptcy Court for relief from the Co-Debtor Stay. The Court may agree to modify or terminate the Co-Debtor Stay when the bankruptcy payment plan does not propose to pay the debt in full and the creditor’s interests would be irreparably harmed, when the co-debtor received the benefits of the debt and the debtor was an accommodation party to the debt (such as when the debtor co-signed for a vehicle loan for the co-debtor who actually obtained the vehicle).
- Creditors may be sanctioned for violations of the Co-Debtor Stay.
If a creditor knowingly violates the Co-Debtor Stay, the Bankruptcy Court may hold the creditor in contempt of court, just as if the creditor had violated the Automatic Stay. The Court may impose fines against the creditor and may award money damages to the injured party. Furthermore, any collections actions taken by a creditor in violation of the Co-Debtor stay are legally void and unenforceable.
- The Co-Debtor Stay is lifted when the Debtor’s case is closed, dismissed or converted to.
The Co-Debtor Stay lifts at the end of the bankruptcy case, or when the case is dismissed, or when the case is converted to Chapter 7 or Chapter 11. After the stay is lifted, the creditor may pursue the co-debtor for payment of any unpaid portion of the debt.
- The Co-Debtor Stay applies in Chapter 12
As discussed in another article, Chapter 12 is similar to Chapter 13, but is reserved for family farmers and fishermen. Chapter 12 bankruptcy has a Co-Debtor Stay in 11 U.S.C. §1201 that is identical to the Chapter 13 Co-Debtor Stay.
- The Co-Debtor Stay could apply to an unusual Chapter 11 bankruptcy case.
As discussed above, the Co-Debtor Stay is specifically provided for by the laws related to Chapter 13 and Chapter 12 bankruptcy proceedings. There is no specific law that applies a Co-Debtor Stay to Chapter 11 cases. However, some Chapter 11 debtors will ask the Bankruptcy Court to impose something like a Co-Debtor Stay against creditors.
The Bankruptcy Court has the power to extend the automatic stay to co-debtors. The debtor must show that irreparable harm will occur to the debtor’s reorganization efforts, that the debtors’ reorganization will likely be successful, and there will be little or no harm to the creditor by the stay. However, Bankruptcy Courts have been particularly wary of using these powers and and only exercise them “unusual circumstances.”
If you have questions about the Co-Debtor Stay and how it might affect you, please feel free to contact us.