As a cosignor, am I still liable when the principal debtor files bankruptcy?
When you sign as a co-signer, you're promising that you will pay the debt in the event the other lender fails to pay it. This means that even if you don't know the debt hasn't been paid, you're still responsible. You may wind up paying for a vehicle or a house that you don't own and have never used.
In most cases, unless the person agrees to repay the creditor in the Bankruptcy Court, the creditor can collect the debt from you. The other person’s bankruptcy may also have a negative effect on your credit rating.
You may have certain rights (especially if the person you co-signed for is a former spouse), and you should seek legal advice immediately after you learn about the bankruptcy.
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.