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Repaying Family Members & Friends Before Filing Bankruptcy Why it is a Bad Idea

A common situation that arises with individuals filing for bankruptcy are loans from family members or friends. After all, if you are struggling financially, it is natural to reach out to your family and/or friends for help. However, if you have borrowed money from a family member or friend and you are thinking of filing for bankruptcy do not repay the loan before filing your bankruptcy. These types of payments are called “Preference Payments” and can cause issues in your Chapter 7 or Chapter 13 bankruptcy case.

What is a Preference Payment?

A preference payment is a payment you make to an unsecured creditor prior to filing a bankruptcy case that allows the creditor to receive more than the creditor would receive in your bankruptcy case. For example, assume Bob owes $5000 to Visa, $3000 to MasterCard, and $2000 to American Express. All three debts are considered unsecured debts.

Bob is considering filing for bankruptcy but does not want to bankrupt his debt to American Express, because he uses the account to purchase supplies for his small business. If Bob pays the $2000 debt to American Express prior to filing for bankruptcy, the payment is a preference: American Express will receive more from Bob prior to the bankruptcy than it would receive in Bob’s bankruptcy case. In Bob’s bankruptcy case, the Trustee will recover the preference payment from American Express and then disburse the $2000 it received to all of Bob’s creditors on a pro rata basis.

How do Preference Payments affect your bankruptcy case?

As discussed above, a bankruptcy Trustee has the power to recover preference payments from creditors that a debtor makes prior to filing a bankruptcy. The look back period for preference payments to ordinary creditors is 90 days. That means, if Bob repays American Express within the 90 days prior to the filing of his bankruptcy case, he must disclose the payment to American Express on his Statement of Financial Affairs. The look back period for “insiders” (family, friends, business partners) is 12 months.

If you have made a preference payment to a regular creditor, the bankruptcy Trustee will recover the payment directly from the creditor. If you have made a preference payment to family member or friend, the Trustee will generally give you the option of repaying the value of the preference payment to the bankruptcy estate. Trustees are not heartless and know individual debtors do not want to involve their family members and friends in their bankruptcy case. No one wants a bankruptcy Trustee to file a lawsuit against their family member or friend to recover the preference payment.

Do I have to disclose the preference payment in my bankruptcy?

I am often asked by clients if they must disclose preference payments made to family & friends on their bankruptcy petition. The answer is YES! You are signing your bankruptcy documents under penalty of perjury. You will testify under oath in your case that your bankruptcy documents are true and correct. If you willfully mislead the bankruptcy court or conceal assets, you are subject to criminal penalties & fines as well as the loss of your discharge. It is simply not worth the risk.

Summary

Do not repay any loans to family members or friends before filing for bankruptcy. Remember, you can repay them after your bankruptcy case has concluded. If you have already made a preference payment and need to file a bankruptcy, you should speak with an attorney and discuss your options. One option is the file a Chapter 13 Bankruptcy which will allow you to repay the preference payment over 36-60 months. Another option is to wait until the look back period has run. Call Treguboff Law, PLC today for a free consultation to discuss your bankruptcy options.