During difficult financial times, you turn to family and friends for help. They lend you money when banks couldn’t, regardless of your credit score. But when your debts pile up, can you pay back your family any money owed to them before filing for bankruptcy?
A quick answer is “no.” You should avoid paying relatives and friends if you plan on filing for bankruptcy. Under the bankruptcy process, all creditors should be treated fairly and equally. If you pay off a relative’s debt, it means you will have fewer assets to distribute to other creditors. When consulting with a bankruptcy attorney at Butcher Law Office, LLC, you will learn what your best interests are and what you should do before filing for bankruptcy.
Are Family Members Considered Creditors?
Bankruptcy law requires you to list all debts and creditors. This will allow the court to give notice to all of them that you’re filing for bankruptcy and are now protected under the automatic stay. You are allowed to list your family and friends on this list.
In a Chapter 7 bankruptcy, your nonexempt property is sold, and creditors share the proceeds, if any. In a Chapter 13 bankruptcy, you make planned repayments, and your family may get some of the money in the course of the plan.
What Are Preference Payments to Insiders?
Paying back a family loan before filing for bankruptcy may seem like the best thing to do, but the court may determine this as a preferential repayment. A “preference” is a payment you make to a creditor within a particular timeframe before filing for bankruptcy.
If you pay any debt within 90 days prior to filing for bankruptcy, it may be considered preferential if the total repayment is over $600. If the creditor is a family member, the transaction will be scrutinized even more, and the preferential transfer extended to a year.
Who Are Insiders?
Bankruptcy law. 11 U.S.C. § 101(31) defines who insiders are. They could include relatives, close friends, or business partners. Simply put, the court already knows that you are likely to “favor” your family and friends over other creditors. A relative under bankruptcy law includes:
- Great grandparents
- Aunts and uncles
- Nieces and nephews
People related to you through adoption or step-relationships are also classified as relatives.
What Happens If I Pay My Family First?
If you already paid a family loan, you may want to delay filing for bankruptcy until one year has elapsed since the repayment date. But if you go ahead and file for bankruptcy and the payment is later considered to be preferential, your good intentions could backfire. The Bankruptcy Trustee may go ahead and file a lawsuit against the family member you paid.
The Trustee can then proceed to recover the money or property on behalf of all other creditors. Having that creditor lose the money you had already paid would be more frustrating to both of you. Instead of being happy you repaid your loan before filing for bankruptcy, he or she will be unhappy being forced to surrender money, probably after having spent it. Consult your Eugene bankruptcy attorney before making these financial mistakes.
How Can I Avoid a Preference?
If you are contemplating bankruptcy, avoid paying anything on any debts to anyone who might be considered an “insider.” That way, you would have prevented any preferences if you were to file a bankruptcy case.
There’s also an exception to this preferential transfer period. A Trustee will only avoid a preferential payment if you were insolvent when you made the payment. You are considered “insolvent” if your debts exceed your assets. So if your assets were greater than your debts at the time, the payment cannot be reclaimed.
The problem is that you cannot easily know if you were solvent at the time or not. Again, this is something your lawyer can help you know.
How Can I Protect My Family’s Interests?
One problem with family loans is that they commonly lack any formality. So the courts genuinely try to protect official creditors. If you don’t want to list your family as creditors in your bankruptcy case but want to take care of their interests, you can wait until the preferential transfer period expires to make payments.
If you cannot wait (many debtors can’t), you may choose to file under Chapter 7 and repay them with the money you earn after filing – even if they were listed in the bankruptcy filing. Under Chapter 7, any money you’ll earn after filing for bankruptcy is all yours, and can do whatever with it.
You may also want your family to receive money through the bankruptcy process. For this, you will need to show an official document that records the loan amount, repayment terms, and parties to the loan. Otherwise, the court will only handle official creditors.
A Local Bankruptcy Attorney Protecting Your Best Interests
If you are in debt and considering bankruptcy, talk to an experienced bankruptcy attorney near you. This is perhaps the best way you can protect your family’s interests. Your bankruptcy attorney in Eugene, OR, will probably ask you to disclose all loans borrowed from insiders and determine if they will be clawed back or not.
At Butcher Law Office, LLC, bankruptcy attorney Tom Butcher will help you protect your family and avoid a preference action. Book a free consultation to discuss your situation and options.