No Discharge of Unsecured Debt for Non-Filing Co-Debtors

By: Carly S. Krupnick

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 

Recently, in In re Faulkner, the Bankruptcy Court for Central District of Illinois held that a lien release provision in a debtor’s chapter 13 plan only released a secured creditor’s lien as to the debtor’s interest, and did not require the secured creditor to release its lien and surrender title to the debtor’s vehicle until the remaining deficiency balance was paid in full by a non-filing co-debtor.[1]  In Faulkner, a secured creditor held a lien on an SUV that the debtor co-owned with a non-filing debtor.[2]  Under the debtor’s chapter 13 plan, the secured creditor’s claim was bifurcated.[3]  The plan also stated that “secured creditors shall retain their liens upon their collateral until they have been paid the value of said property.”[4]  After the debtor completed her plan and received her discharge, however, the secured creditor refused to return the certificate of title to the debtor’s SUV because the non-filing debtor had not satisfied the remaining deficiency balance in full.[5]  The debtor responded by filing an adversary proceeding alleging that the secured creditor violated the discharge injunction.[6]  The court found that “there is nothing in [section] 524 that prevent[ed the secured creditor] from asserting its rights against the non-filing co-debtor for the deficiency balance,”[7]  and therefore, the secured creditor was not barred from bringing action against a non-filing co-debtor once the case was closed.[8]  Thus, the court concluded that “the debtor’s plan, no matter how clear and conspicuous, can only serve to release [the secured creditors]’s lien as to the debtor’s interest in the vehicle. . . [and the secured creditor]’s lien remains in place and can be enforced against the non-filing co-debtor’s interest in the vehicle” until the entire amount owed under the contract was paid in full.[9]  

Section 524(e) states that the “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for such debt.”[10]  In chapter 11 cases with consenting creditors, courts have held that a plain reading of section 524(e) does not preclude releasing a non-filing co-debtor, and that “a per se rule prohibiting injunctions and releases is ‘similarly unwarranted if not a misreading of the statute.’”[11]  However, In re Faulkner illustrates the universal rule that bankruptcy courts cannot discharge or release a co-debtor in a chapter 13 plan even if the creditor consents.[12]  Policy considerations underlie the rule allowing creditors to collect from co-debtors.[13]   For example, in In re Jackson, the court opined that discharging a lien on an automobile would be inequitable because the co-debtor would receive the benefit of the lien release without complying with her payment contract.[14]  Additionally, In re Harris noted that disallowing a creditor to collect from a co-debtor after discharge produced an unfair effect on creditors because cosigners are often used to lessen the risk of non-repayment, and without the ability to collect from the cosigners creditors loses the “benefit of the bargain” they made with the debtor.[15]

The rule disallowing non-consensual co-debtor releases in chapter 13 plans may have significant impacts on both bankruptcy debtors and non-filing co-debtors.  If the debtor files for bankruptcy, the co-debtor will be liable for the remaining unsecured balance.  This in turn may put pressure on bankruptcy debtors to help pay the unsecured balance after the debtor receives a discharge because “many cosigners are friends and relatives of the debtor, who want to and maybe even feel obligated to help their loved one.”[16]  Fortunately, a debtor may have other options besides simply paying the discharged unsecured balance.  Although a chapter 13 plan cannot unilaterally discharge a co-debtor, courts have allowed debtors to provide in their chapter 13 plans that claims arising from the unsecured debts held with co-debtors have priority over the non-priority claims filed against the debtors’ estate.  For example, in In re Rivera, the court confirmed a chapter 13 plan despite the fact that the plan allowed a claim arising from a co-signed debt to be paid in full while the rest of the unsecured claims received only a payment of four and one half percent because the plan met the statutory requirements for separate classification and was proposed in good faith.[17]  Such treatment allows the debtor to pay off all or most of the cosigned debt, thereby relieving him of the moral obligation to help the co-debtor repay the debt after the debtor receives his discharge.[18]  

 


[1] 07-81412, 2013 WL 2154790, at *5 (Bankr. C.D.Ill. May 17, 2013).

[2] Id. at *5.  The co-debtor was identified as the other owner on the car’s certificate of title.  Id.

[3] Id.

[4] Id.

[5] Id.                                                   

[6] Id. The debtor tried to argue that once her secure debt was paid to the creditor, CEFCU was obligated to release the certificate of title to the vehicle regardless of the existence of a non-filing co-debtor on both the title and installment contract.  Id.

[7] In re Faulkner, 07-81412, 2013 WL 2154790, at *2 (Bankr. C.D.Ill. May 17, 2013).

[8] Id.  (noting section 1301 only imposes stays protecting non-filing co-debtors from collection efforts during bankruptcy proceedings).

[9] Id.

[10] 11 U.S.C. § 524(e) (2012).

[11] 168 B.R. 930, 934 (Bankr. W.D. Mo. 1994) (quoting In re Specialty Equip. Co., 3 F.3d 1043, 1047 (7th Cir.1993)) (reasoning since section 524 has no specific language banning discharge of co-debtor, discharge is allowed when warranted).

[12] In re Faulkner, 07-81412, 2013 WL 2154790, at *5 (Bankr. C.D.Ill. May 17, 2013); see also In re Leonard, 307 B.R. 611, 614 ( Bankr. E.D. Tenn. 2004) (holding debtor was no longer liable to creditor, but non-filing co-owner remained liable); but see Arrowmill Dev. Corp. 211 B.R. 504 (Bankr. D.N.J. 1997) (noting three lines of cases emerging in chapter 11 plans, including one allowing non-debtor discharge even over objections of creditors).

[13] See In re Faulkner 2013 WL 2154790, at *5; In re Jackson, 2-10757-JDW, 2012 WL 6623497, at *3 (Bankr. M.D. Ga. Dec. 18, 2012); In re Harris, 16 B.R. 371, 376 (Bankr. E.D. Tenn. 1982)

[14] Jackson, 2012 WL 6623497, at *3 (Bankr. M.D. Ga. Dec. 18, 2012).                             

[15]16 B.R. at 376.

[16] In re Brown, 266 B.R. 900, 908 (S.D. Ga. 2011).

[17] 490 B.R. 130, 140–41 (B.A.P. 1st Cir. 2013).  The case follows a three part test to apply the unfair discrimination rule found in section 1322 of chapter 11.  Id.  The court examined (1) whether the claim was considered a co-debtor consumer claim, (2) which party received the preferential treatment, and (3) whether the plan satisfied all other requirements for confirmation. Id.

[18] Id