The Dangers of Repaying Personal Loans Prior to Filing Chapter 7
Insider Creditors & Preference Payments in Chapter 7 Bankruptcy
When you file a bankruptcy petition, you create a legal "bankruptcy estate" containing all of the property that you own at whatever value it happens to have on the date that you file the bankruptcy petition. In a Chapter 7 bankruptcy, an individual called the Chapter 7 Trustee is assigned to your case by the bankruptcy court upon filing, and it is the Chapter 7 Trustee's job to seize unprotected assets in the bankruptcy estate and sell them off in order to give the resulting proceeds to your creditors, who will otherwise receive nothing for the debts you owe them that are discharged. (Assets are protected in a Chapter 7 by the application to each asset in the bankruptcy petition certain statutory "exemptions" which "exempt" or remove the assets from the bankruptcy estate---and thus from the Chapter 7 Trustee's administrative control.) The bankruptcy estate can also contain assets you do not yet own, such as an inheritance that you receive 5 1/2 months after you file your case, even if you had no idea you would be receiving the inheritance. It can also contain assets you used to own. And this includes cash you have repaid to your creditors within certain time-period prior to the filing of the bankruptcy petition. And "creditors," in bankruptcy, includes any person or entity you owe money to, even your grandmother or best friend, and even if there isn't a shred of documentation establishing the existence of the debt---and no matter how small the amount of money involved may be.
Insider Creditors and The Preference Period Defined
First, what time-period prior to filing are we concerned with? For a "regular" commercial creditor, such as American Express or a medical debt, a payment of $600 or more in total made over the 90 days prior to the filing of the petition must be disclosed in the bankruptcy petition as a "preference payment." For an "insider creditor," which includes a family-member, a corporation you have an ownership interest in, a boss or other individuals with influence over you, and, in some cases, friends, any repayment on a pre-existing debt of $600 or more in total (could be multiple payments) made in the 12 months prior to filing is considered a "preference payment."
Preference Payments and the Bankruptcy Estate
A "preference payment" is considered to be an asset of the bankruptcy estate because the Bankruptcy Code (the Federal statute governing the bankruptcy process in the US) says that all similarly classified creditors (secured, unsecured, etc.) must receive an even-Steven split of any funds recovered from your bankruptcy estate. Thus, if you've preferred to pay American Express $601.00 89 days prior to filing your Chapter 7 case, the Chapter 7 Trustee can pursue American Express to retrieve that $601.00 in order to redistribute equitably to all of your other unsecured creditors. Friends and family-members and other recipients of repayments on personal loans are just unsecured creditors like American Express, as far as the Bankruptcy Code is concerned. Thus, if you prefer to repay your grandmother $601.00 11 months prior to filing, the Trustee can sue your grandmother to retrieve the $601.00 in order, again, to redistribute the proceeds equitably to your other unsecured creditors. The logic is that that $601.00 would have been part of your bankruptcy estate available to potential distribution to your creditors in bankruptcy had you not gone ahead and repaid your grandmother with it.
Chapter 7 Bankruptcy and Insider Creditors: The Bottom Line
The first take-away from this post should be that, if you think you may need to file for Chapter 7 bankruptcy, refrain from repaying any creditors before speaking to an experienced bankruptcy attorney. The second take-away should be that you cannot assume that just because a loan is "personal" or "not documented" or "not for very much money," that it isn't going to have to be disclosed. All debts and assets must be disclosed in every bankruptcy petition. There are a number of defenses available to Trustee pursuit of an insider or other preference payment, but you will need a competent and experienced lawyer to assist you with those. Additionally, there is almost always the option of simply settling with the Trustee to personally pay the value of the preference payment so that he or she does not sue your grandmother. Finally, there is always Chapter 13 bankruptcy, in which, although the same disclosures must still be made, no assets are liquidated because you make monthly payments based on what you can afford to repay to your creditors. Preference payments are not generally pursued by Chapter 13 Trustees. But you need help with any of these options. Frequently, attorney John Hilla of The Hilla Law Firm receives inquiries from potential clients asking for price quotations over the telephone, claiming that their case will be "very simple." Preference payments to insider creditors are one of the most common ways an allegedly "simply" Chapter 7 becomes not so simple after all. Do not assume. If you are a Michigan resident and would like to explore your options for a Chapter 7 or Chapter 13 bankruptcy with an experienced Michigan bankruptcy attorney, please contact us at (866) 674-2317 or click the button below to schedule a free, initial consultation.
If you enjoyed reading "Chapter 7 Bankruptcy and Insider Creditors," please browse our other articles on our main Michigan Bankruptcy Blog.