Chapter 13 bankruptcy provides some protection for cosigners when another person liable for a debt files bankruptcy. However, this protection, while valuable, is still limited. To the extent that creditors are not made whole by the bankruptcy plan, they may eventually proceed against loan cosigners.
Chapter 13 vs. Chapter 7
The two most common forms of bankruptcy for private citizens are Chapter 13 (debt adjustment) and Chapter 7 (liquidation). In a Chapter 13 bankruptcy, a repayment plan is developed under which the bankrupt debtor will pay creditors as much as possible over 3 - 5 years, after which any remaining debt is discharged (eliminated). Under Chapter 7, the debtor's assets are liquidated, and the proceeds distributed to creditors, after which debts are discharged.
Cosigners
A cosigner is another person liable on a loan. From the point of view of the lender, the cosigner is equally liable with the signor--that means that the bank has just as much right to go after a cosigner as it does to go after the person who "took out" the loan. The fact that the cosigner may not have gotten the benefit of the loan doesn't matter. For example, say that a parent cosigns a car loan for her child. The child owns and drives the car; the parent gets no value or use from it. Notwithstanding that, if the loan is not paid on time, the bank can sue the parent for the amount owed. This is why, by the way, many attorneys recommend that you NEVER cosign someone else's loan if you can at all help it; cosigning gives you all the liability and obligations of a loan without getting the benefit of either the money or the goods or services purchased therewith.
Chapter 7: No Protection for Cosigners
If someone files Chapter 7 bankruptcy, the lender can--and probably will!--go after any cosigners for payment. Chapter 7 provides literally no protection for cosigners.
Chapter 13: A Temporary Stay and Limited Protection
When bankruptcy is filed, collections efforts against the debtor are temporally halted, or stayed. Chapter 13 extends that stay to any cosigners, at least for "consumer" loans (personal, family, or household debt; not business loans). During the duration of the temporary stay, creditors cannot go after the cosigner. Also, whatever payments will be made under the plan will be credited against the cosigner’s obligation, reducing what he or she might have to pay.
Unfortunately, the cosigner’s obligation is not discharged--ultimately, a cosigner is liable for any amounts owed to the lender not paid either before bankruptcy or as a result of the bankruptcy plan. Therefore, there is a very good chance that any cosigners will eventually have to pay at least part of the debt, since it is very unlikely that the Chapter 13 plan will see it fully paid.
How an Attorney Can Help
If you cosigned a loan and the person you cosigned it for is experiencing financial distress, consult with a bankruptcy attorney immediately. An attorney can help you protect your interests from the actions of the other parties to the debt.
