There is a great line by the band Faces (and if you aren’t cool like me and don’t know who that is, it is a band featuring the amazing vocal talents of Rod Stewart) that goes, “I wish that I knew what I know now when I was younger.” Well, I’m glad that I know what I know now as a bankruptcy attorney. Even those most savvy attorney can learn a few life lessons from his/her clients. Besides the obvious lessons, the greatest lesson I have learned as a bankruptcy attorney is never, and I mean NEVER, co-sign with someone on a loan. I don’t care if you really love the person; or that you trust them, or that they are the greatest and most financially sound person you have ever known. Co-signing for a debt will not end well.
We have clients on both sides of the coin on this issue. Some of our clients are filing for bankruptcy because they have co-signed for a friend or family member. That really trustworthy friend or family member has now fallen behind on the loan (for whatever reason), and it is in default. This is not good because, as the co-signor, our client is now responsible for the defaulted loan as well. Perhaps the co-signor has now filed bankruptcy. Well, that’s great because the debt will be discharged, right? Not exactly. Yes, the debt will be discharged, but only as to the person who filed bankruptcy, not the non-filing party. This leaves the non-filer open to a lawsuit and garnishment. If the co-signor files under Chapter 7 bankruptcy, the non-filing party will be liable for all of the debt owed to the creditor. There is some hope if the co-signor has filed under Chapter 13. When a bankruptcy is filed, the individual seeking relief under the bankruptcy code (aka the debtor) receives an automatic stay of any collection actions. This stay applies to all actions, including garnishments, phone calls, foreclosures, and repossessions. In a Chapter 13 bankruptcy, the automatic stay is also applied to any co-debtor(s) (11 U.S.C. Sec. 1301). However, the protection is not full-proof. First, in a Chapter 13 bankruptcy, the debtor is not likely to re-pay 100% of his/her debt. Generally, he/she will enter into a payment Plan that will pay unsecured creditors (credit cards, etc..) pennies on the dollar. Some secured debts, like a car loan or second mortgage may also be crammed down and only paid to the market value of the collateral. When the debtor receives a discharge, the automatic stay is no longer in place. That’s fine for the filer because he/she successfully received a discharge of any unpaid debt. But, the non-filer did not receive this, and creditors may pursue the non-filer for any remaining unpaid portions of the debt. Second, if something occurs and a creditor has grounds, it can petition the bankruptcy court to lift the automatic stay. This is typically referred to as a Motion for Relief from the Automatic Stay. Relief can be granted from both the debtor and co-debtor, leaving both parties open to continuing liability for the debt.
As I said, we have clients that are sometimes pushed into bankruptcy by defaulting co-signor, but sometimes our clients are the ones defaulting. All the same rules stated above apply, but in this case we must notify all co-debtors of the bankruptcy filing. This makes the co-signor aware of what is going on, so he/she can consult an attorney about the need, if any, to file his/her own bankruptcy.
So, to follow the wisdom of Rod Stewart, life is full of lessons. Sometimes we learn them to late, and sometimes we learn them in the nick of time. Luckily, my lesson learned as a bankruptcy attorney was not too late, but it is one that I will never forget.