Many people have loans or debts that a friend or relative has guaranteed or co-signed. In these situations, debtors considering bankruptcy are often concerned whether a discharge of indebtedness will also absolve co-signors of their responsibility for the debt.
Generally, bankruptcy discharge does not absolve a co-signor or guarantor of the responsibility to pay the creditor any deficiency owed by the party who filed bankruptcy. Creditors can still go after a co-signor for any unpaid balance after a Chapter 7 bankruptcy discharge. Similarly, at the conclusion of a Chapter 13 repayment plan, a creditor can still go after a co-signor for the difference between the amount paid under the payment plan and the original contract amount of the debt (the “deficiency”).
Also, a Chapter 13 bankruptcy filing stays actions by creditors against co-signors during the pendency of the bankruptcy case, but that is not the case in Chapter 7 bankruptcies.
The U.S. Court of Appeals for the Ninth Circuit explained that “[g]enerally, discharge of the principal debtor in bankruptcy will not discharge the liabilities of co-debtors or guarantors.” Explaining that “[t]he bankruptcy court ‘has no power to discharge the liabilities of a bankrupt’s guarantor,” the court clarified that “‘[t]he bankruptcy court can affect only the relationships of debtors and creditor. It has no power to affect the obligations of guarantors.’”
The New York Appellate Division further clarified that “a defendant’s liability as a guarantor generally is not impaired by the discharge of a principal’s obligation in a bankruptcy proceeding and, thus, plaintiff may seek recovery from defendant notwithstanding [the debtor’s] bankruptcy petition.”
The exact language of the agreement in which the co-signor or guarantor took on the obligation is important. If the co-signor only assumed the obligation to pay the debtor’s indebtedness as long as the debtor himself is obligated to pay the loan, then the debtor’s discharge would probably absolve the co-signor of the obligation to guarantee the loan as well. But where the co-signor’s original obligation is not contingent on the primary party’s obligation, or where the agreement explicitly states that the co-signor is obligated regardless of any discharge of the primary party’s indebtedness, the creditor can still go after the co-signor for any amount remaining due.
Based on these rules, it is imperative that anyone who would like to help out a business associate, family member, or friend by co-signing a loan or guarantee should carefully consider whether they are willing and able to pay that person’s debt off if the person asking for help becomes unable to fulfill his financial obligations or files for bankruptcy.
Benjamin Wolf is a Law Clerk at The Law Offices of Elliot Schlissel, a multi-service law firm serving clients in the five boroughs of New York City, as well as Nassau, Suffolk, and Westchester counties.
Effect of discharge, 11 U.S.C. § 524(e).
Stay of action against codebtor, 11 U.S.C. § 1301(a), (c).
Underhill v. Royal, 769 F.2d 1426, 1432 (9th Cir. 1985), rev’d on other grounds 494 U.S. 56, 64 (1990).
Culver v. Parsons, 777 N.Y.S.2d 536, 538 (N.Y. App. Div. 2004).
First National Bank of Scotia v. Proem-a-Net Economics Corp., 652 N.Y.S.2d 405, 407 (N.Y. App. Div. 1997).