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Can You Prefer Creditors Before You File?

Can you prefer certain creditors such as family members before you file bankruptcy?

As a general rule, you cannot prefer certain creditors, such as family members, right before you file bankruptcy, without consequences. However, that is merely a general rule and each situation depends on the facts at play. Therefore, if you have paid money to friends or relatives just prior to filing bankruptcy, it can be proper in certain circumstances.

Depending on how the payment to your family member is structured, it is possible the payment will be determined to be legitimate, and the family member will not have any issues keeping the funds.

The first and most critical question to ask is- was the payment to a family member either a repayment of a debt or was it a gift? In other words, did you owe the family member any money, or did you pay them some of the funds that you owe just because you felt like being generous?

If it was a gift, there are some major potential negative consequences. For starters, a gift can certainly be rescinded by your trustee. This will depend on the amount of the gift, as well as the date the gift was made. The federal look back on avoiding a gift transfer prior to filing bankruptcy is two years and it could be even longer under your state law. For example, if the gift was just a nominal hundred dollar gift, it is of no consequence. However, if the gift was larger, there certainly is the potential that the trustee would rescind the gift.

Now let’s take the scenario that the payment to a family member was not a gift and you in fact owed money to the family member. Now you must look at what kind of debt was it is. Was it an unsecured debt where the creditor or your family member did not have any interest in any of your collateral? Or, was it a secured debt in which your family member took a security interest in a piece of your collateral when they lent you the money? 

If it was a secured debt, payments made in the normal amount of the loan and in the ordinary course of business should be okay. If on the other hand, the payment to them was either an extraordinary amount or not in line with the agreement, then there is a potential problem and the transfer can be rescinded.

However, it’s most important to know whether it was in fact a legitimately secured debt. You might have intended for it to be a secure debt, but no security interest or perfection of the security interest, was ever filed. If so, it’s actually an unsecured debt.

The look back on rescinding unsecured debts as to any creditor is 90 days if the amount paid was greater than $600. A family member however is referred to as an insider, and the look back period for an insider transfer is one year. 

Therefore, let’s say you were repaying your family member $500 a month for the past year. That is potentially $6,000 your trustee could seek to recover from your family member. This is why it is so critical to avoid repaying debts to family members before you file your case.

Therefore, if you pay money to family members before you file, it is very important that you understand what the nature of your relationship and whether you your family member was in fact a creditor of yours.

Finally, it’s important to note that you must disclose all these payments whether they were legitimate repayments of secured debts or not because failure to disclose these payments could result in the trustee or a creditor challenging your discharge. 

In this scenario, not only could the transfers be rescinded, but the debtor could in addition also be denied a discharge of all of his debts.

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