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Debt Collection Protection Using Chapter 13 Bankruptcy Co-Debtor Stay

Michael S. Anderson Jan. 27, 2017

In most bankruptcy cases, a powerful tool called the “automatic stay” comes into existence the moment the case is filed. This “stay” prevents almost every type of debt collection from continuing. A home foreclosure, car repossession, and garnishments all end by operation of law. The automatic stay applies to the “debtor” or “debtors” who actually file the bankruptcy case.

But sometimes the debtor filing the bankruptcy has a co-debtor (someone who owes the debt jointly) who can't or won't file bankruptcy. In those cases, the question becomes whether the automatic stay will stop debt collection activity for them as well. In certain situations, it will via the “co-debtor stay”.

The Co-Debtor Stay and How It Works

Imagine a husband and wife who have jointly financed the purchase of some nice furniture for the family room. They are both on the hook to pay the loan for the furniture either or both of them sign the loan documents. (Arizona is a community state so what binds one spouse binds the other).

The couple later has financial problems and the wife decides to use chapter 13 bankruptcy to deal with the debt. The husband doesn't file the case with her. The wife is protected by the bankruptcy filing's automatic stay…but is the husband as well? Can the bank that lent the money on the furniture sue the non-filing husband who is outside the bankruptcy case? No, the creditor can't sue the Husband.

In a chapter 13 case, the automatic stay applies twice. Once for the filer of the case and once to the co-debtor on a specific debt.

Even though we used a husband and wife example, the co-debtor stay applies to non-spouses as well in a chapter 13 bankruptcy. It will protect anyone jointly responsible.

The Co-Debtor Stay Has Some Limits

Not in Chapter 7 Bankruptcy

The first limitation on the co-debtor stay is that it never applies in a chapter 7 case. Some people use chapter 13 bankruptcy just for the purpose of protecting a co-debtor even when chapter 7 makes more sense for other reasons.

Only Consumer Debt

The second limitation is that the co-debtor stay only applies to consumer debts. A consumer debt according to the bankruptcy code is a debt incurred primarily for a personal, family or household benefit. The co-debtor stay doesn't apply to tax or business related debt.

Court Ruling

Under section 1301(c) of the bankruptcy code the Bankruptcy Judge can lift the co-debtor stay and allow the creditor to continue collection if the creditor files a motion and one of three circumstances are true. First, if the co-debtor was the party that actually received the benefit of the loan as opposed the bankruptcy filer. Second, if the chapter 13 filer's plan doesn't propose 100% payment on the creditor's claim. Third, if the creditor would be irreparably harmed by the co-debtor stay.

Once a motion to lift or remove the co-debtor stay is filed, a hearing is held. If the creditor is alleging that 100% of the debt won't be paid, the stay is lifted automatically after 20 days if no objection is filed by the debtor or co-debtor.