If you jointly owe a debt with a co-signer, bankruptcy can protect you from the creditor and from your co-signer, or protect your co-signer.
Consider these two opposing scenarios in which a co-signer helped you get a loan or incur some other kind of debt, and now you are both getting sued by the creditor:
1) You’ve since then had a falling out with the co-signer, and all you care about is escaping the debt yourself regardless what happens to your co-signer; or
2) You believe you have a moral or some other duty to protect the co-signer, so that’s what you want to do.
The first scenario I’m going to address today, and then the second one in my next blog post.
If you and your co-signer are being pursued by your creditor, and you can’t pay the debt, you have two different obligations to worry about—a definite one to the creditor and a likely one to the co-signer.
Protecting Yourself from the Creditor Itself
The obligation to the creditor is based on your promise to pay the debt. Most likely that obligation can be discharged (legally written off) by filing bankruptcy, either a Chapter 7 or Chapter 13 case, whichever is better for you otherwise.
Like any other creditor, this one could object to the debt being discharged if you committed fraud to acquire the debt. But these kinds of objections are rare, and the creditor must raise them within about three months after you file the case. If you have any concerns about whether this might happen to you, talk with your attorney when first meeting with him or her.
Protecting Yourself from Your Co-Signer
You likely also have a legal obligation to your co-signer, one separate from your obligation directly to your creditor. But whether or not you really do owe anything to your co-signer depends on your situation.
A financial obligation to your co-signer would likely only arise if your co-signer pays part or all of your debt to the creditor. Even then, whether you would owe the co-signer would depend on the details of you and your co-signer’s understanding about your obligation to him or her.
Most likely you and the co-signer did not write out the terms of your obligation, and you may not have even talked about those terms clearly. If not then any obligation you may have to the co-signer would have to be inferred, based on some unspoken assumption that you would make the co-signer whole if the co-signer ever had to pay the creditor any of the debt. For example, if of a friend or relative who you know was doing you a big favor to co-sign for you, could not easily afford to pay the debt, and would really need and want you to pay him or her back, then your promise to repay him could perhaps be legally inferred..
But there could also be a sensible inference—under other facts—that you and the co-signer did NOT expect you to pay it back. For example, if your co-signer is a well-off relative who could easily afford to pay the co-signed debt, “lent” you money in the past without expecting you to pay it back, and gave you no indication that this situation would be any different, most likely there was no legally binding promise by you to repay your co-signer.
Let’s Get Practical
Usually the creditor is going to pursue both you and your co-signer. If you can’t pay the creditor, usually there’s not likely much point in defending against a legal obligation to the co-signer. The creditor would likely just try getting the money out of you by filing a lawsuit, followed by garnishment of your paychecks and such. So you have to deal with both obligations at once—the definite one to the creditor and the possible one to the co-signor.
A bankruptcy would likely permanently discharge both these obligations, protecting you from both.
If you do file bankruptcy, be sure to list among your creditors not just the creditor but also your co-signer. Otherwise you could remain liable to the co-signer after your bankruptcy case is finished.
Your co-signer could object to the discharge of his or her claim against you (just like your creditor could, as mentioned above) based on allegations that you defrauded the co-signer, such as by lying about your ability to pay the debt on your own.
Again, these kinds of objections are rare, but they do tend to be raised more often by former friends, ex-spouses, ex-business partners, and such. That’s because 1) they more likely have a personal axe to grind, 2) it’s easier for misunderstandings to arise in informal arrangements, and 3) these kind of people tend to know more about you and your intentions than would a conventional creditor.
The best way to protect yourself from such challenges to discharge is to explain the situation thoroughly to your attorney. He or she can then assess the risk that a challenge will be raised either by the creditor or by your co-signer, and can prepare your bankruptcy documents proactively.