Chapter 5, H. The Stay as It Applies to Co-Debtors

• Jurisdiction: United States

H. The Stay as It Applies to Co-Debtors

Generally, the automatic stay does not protect co-debtors.¹³³ A plaintiff may pursue a claim against an unrelated nondebtor, even when a co-defendant files for bankruptcy.¹³⁴ "[T]he automatic stay is not available to solvent co-defendants of a debtor even if they are in a similar legal or factual nexus with the debtor."¹³⁵ The automatic stay does not apply to actions against guarantors, sureties, corporate affiliates and other nondebtor parties who are liable on a debtor's obligations.¹³⁶

However, an entire action may be halted if there is an "unusual circumstance" or "when a third party is taking action that circumvents the automatic stay in a debtor's bankruptcy case."¹³⁷ An example of an unusual circumstance would be where there is an action against a third party who will be absolutely indemnified by the debtor if a judgment is entered against the third party in the case.¹³⁸

In theory, litigation involving multiple parties, one of which is an entity that files for bankruptcy, would be stayed only as to the debtor. However, in practice, state court judges may stay the entire action. This is the result of unfamiliarity with bankruptcy law coupled with the fear of violating it. Some courts have what is referred to as a "bankruptcy docket." A case is referred to the bankruptcy docket when a defendant files for bankruptcy. However, a case may also be stayed or placed on the bankruptcy docket even when there exists an unrelated solvent defendant. The burden will then be on the plaintiff to convince the judge that the stay is only effective as to the debtor. Alternatively, a plaintiff may choose to dismiss the debtor or sever the actions.

The stay is designed to protect only the debtor and property of the estate. In one instance, the primary carrier of a debtor sought reimbursement of $2.6 million in damages from the excess carrier. The excess carrier requested a stay of the proceedings until the closure or dismissal of the debtor's bankruptcy proceeding. The court denied the request for stay, stating that the protection, or "insulation," belongs exclusively to the debtor in bankruptcy. The stay of actions against the debtor/insured does not operate for the benefit of the insured.¹³⁹

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Notes:

^[133] 11 U.S.C. §§ 1201(a) and 1301(a) provide for a co-debtor stay.

^[134] 555 M Mfg. Inc. v. Calvin Klein Inc., 13 F. Supp. 2d 719 (N.D. Ill. 1998).

^[135] Lynch v. Johns-Manville Sales Corp., 710 F.2d 1194, 1196-1197 (6th...