Defining and Terminating the Co-Debtor Stay

Often, more than one person is liable to a creditor under a security agreement or on a credit card account. Yet, in many instances, only one of the liable parties on an account will file bankruptcy (the debtor), while the other person (the non-filing co-debtor or NFCD) does not. As creditors are keenly aware, once a person files for bankruptcy, the Automatic Stay prevents acts to collect the debt from the debtor. Chapter 13 debtors are afforded the additional protection of the Co-debtor Stay. The following is an overview of the Co-debtor Stay and the procedure to terminate the Co-debtor Stay so that collection activities can commence against the non-filing co-debtor (NFCD).

In petitions filed under Chapter 7 or Chapter 11 of the Bankruptcy Code, there is no co-debtor stay and the creditor may proceed with collection activities against the co-debtor under applicable state law. The policy behind the co-debtor stay in Chapter 13 is to prevent creditors from placing indirect pressure on the debtor by continuing collection activities against co-debtors, who are usually the debtor's spouse, family members or friends. Where a debtor files a petition under Chapter 13, the Bankruptcy Code provides protection to co-debtors of the debtor, if the debts for which the co-debtor is liable with the debtor are consumer debts, usually meaning they were incurred for personal as opposed to business purposes.

The effect of the co-debtor stay is that if a consumer has filed for bankruptcy under Chapter 13, and there is a co-debtor on the account, the creditor must not attempt to collect the debt from the co-debtor. Doing so is a violation of the co-debtor stay and the creditor may be subject to sanctions for a violation. Creditors are not forever barred from pursuing the co-debtor, but they will have to wait until the debtor's Chapter 13 case is completed before they can attempt to collect the debt from the co-debtor. Creditors are not without recourse, however, in cases where the co-debtor stay applies.

Creditors can file a Motion for Relief from the Co-debtor Stay and ask the Court to terminate the Stay under any one of three appropriate circumstances. First, under section 1301(c)(1) of the Bankruptcy Code, the co-debtor stay can be lifted if, as between the two parties on the account, the NFCD actually received the benefit from the account or debt. Second, pursuant to section 1301(c)(2), the stay must be lifted if the debtor's Chapter 13 Plan does not propose to pay 100 percent of the creditor's claim. Finally, under section 1301(c)(3), the stay must be lifted if the creditor would be irreparably harmed by continuation of the co-debtor stay. Generally, once a Motion for Relief from Co-debtor Stay is filed, a hearing will be held to determine if the stay should be lifted or modified. However, if the Motion is filed under section 1301(c)(2), alleging that the Plan does not propose a 100 percent payment to the creditor of a co-signed debt, the stay is automatically lifted 20 days after the filing of the Motion unless the debtor or co-debtor files a written objection to the Motion.

Usually, a Motion for Relief from Co-debtor Stay involves proving who is actually liable on an account and whether the creditor actually holds a claim against the co-debtor. Under these circumstances, a creditor may be asked to produce documentation establishing the co-debtor's liability, such as a signed application for credit.

Another common defense to a Motion for Relief from the Co-debtor Stay is that the debtor assumed the debt as part of a divorce. Therefore, the argument goes, the creditor should not be permitted to lift the Stay protecting the non-filing spouse because the debtor agreed to accept full liability for the debt as part of the divorce settlement. Unfortunately for the non-bankrupt spouse, this argument usually fails. Generally, the allocation of debts pursuant to a divorce decree does not bind the creditor. That is, the divorcing spouses cannot alter the creditor's contract with them to alleviate one party's liability for a debt without the appropriate notice to the creditor if it is done in a court with jurisdiction over the creditor or the creditor's consent. If the debtor's Plan is not amended to pay the debt at 100 percent, the Stay will be lifted and the creditor can pursue collection against the non-filing spouse. Of course, since the parties are divorced, often the debtor has no incentive to agree to pay the debt 100 percent through the Plan. If the NFCD is required to make payment on the debt, the terms of the divorce decree would give the NFCD a cause of action against the debtor's ex-spouse to recover any losses. But, since the debtor is in bankruptcy and presumably will receive a discharge, the non-filing spouse will likely be unable to enforce the terms of the divorce decree to make the debtor pay for any losses.

NFCDs also commonly oppose a creditor's Motion for Relief from Co-debtor Stay because they are unable to pay the debt. Nevertheless, the Court should grant the Motion for Relief if the debtor's Chapter 13 Plan does not provide for 100 percent of the creditor's claim, which under the Bankruptcy Code, is a clear reason to terminate the co-debtor stay. The inability of the NFCD to repay the debt is not a defense to the Motion.

Once a Motion for Relief from Co-debtor Stay is granted and the co-debtor stay is terminated, the creditor can then proceed against the co-debtor under the appropriate non-bankruptcy, state court collection laws. Often the bankruptcy courts will only allow relief from the co-debtor stay to the extent the debtor will not be paid through the plan. For example, if the debtor's plan calls for the creditor to be paid 30 percent through the plan, the court may grant relief so the creditor can pursue the remaining 70 percent of the debt.