The natural instinct is to pay back family after they’ve helped you through tough times. But if you’re thinking of filing bankruptcy, paying back family can have devastating consequences. Read on to find out why.
It’s tempting to take care of family members first.
Family can be wonderful in tough times. So if bankruptcy is on the horizon, it’s only natural that they should be paid back before other creditors. After all, it’s better for Uncle Bob to be paid instead of the credit card company, right?
Eh, not quite. Paying back family members can complicate a bankruptcy filing. And make family gatherings rather tense.
Here’s an example. Suppose Uncle Bob makes his niece’s mortgage payments while she is going through a particularly nasty divorce. Niece later receives the divorce decree and the home is sold. She nets $10,000 from the sale and pays Uncle Bob back for the mortgage payments. Saddled with a bunch of the marital debt, Niece files for bankruptcy four months later.
The bankruptcy trustee then files a lawsuit against Uncle Bob for return of the $10,000. Why?
Bankruptcy trustees can (and love to) recover preferential payments.
Because a bankruptcy trustee is tasked with recovering non-exempt property for creditors. This includes recovering “preferential payments“. A preferential payment is a debt payment made to a creditor in the 90-day period before a debtor files bankruptcy (or within one year if the creditor was an insider) that gives the creditor more than the creditor would receive in the debtor’s chapter 7 case. Absent certain exceptions, the Bankruptcy Code allows the trustee to avoid – or recover from the creditor – such transfers.
To recover a preferential payment under 11 U.S.C. 547(b), the trustee must show that the payment was made:
- to or for the benefit of the creditor;
- for or on account of an antecedent debt owed by the debtor before the transfer was made;
- while the debtor was insolvent;
- made on or within 90 days before filing, or between 90 days and one-year before filing if creditor was an insider; and
- enables the creditor to receive more than such creditor would receive if the case is a chapter 7, the transfer had not been made, and the creditor received payment of the debt to the extent provided by the Bankruptcy Code.
In this case, the niece’s payment of $10,000 to Uncle Bob in the months leading up to her bankruptcy filing could be considered a preferential payment. As a debtor, she is also presumed to have been insolvent in the 90 days leading up to the bankruptcy filing.
So the niece should just wait 90 days from the date of the transfer and then file bankruptcy, right?
Payments to insiders can be avoided up to one-year before bankruptcy.
Not so fast. The Bankruptcy Code extends the period for transfers to “insiders“, or family members of the debtor, for a period of up to one year before filing bankruptcy. There is also section of the bankruptcy petition called the “Statement of Financial Affairs” which requires such transactions be reported. Under oath.
In this case, since Uncle Bob is a relative of the debtor and the payment was made between 90 days and one-year leading up to the bankruptcy filing, the bankruptcy trustee may file a lawsuit to recover the payment to Uncle Bob. Needless to say, Uncle Bob would not be too happy the next time he sees his niece at Thanksgiving.
So how could this be avoided? The easiest way is to not make the payment to a family member before filing bankruptcy. If the payment was made, then the next best alternative would be for the family member to return the payment. The funds could then be spent down appropriately before filing bankruptcy. Either way, a frank discussion with a competent bankruptcy attorney could save a good deal of frustration and drama at the next family reunion!
If you have questions about filing bankruptcy, please contact Matt Cree by email or call us for a free consultation.