Don’t pay back family before filing for bankruptcy
Avoid paying back family or friends before filing for bankruptcy, it could expose them to a lawsuit filed by the bankruptcy trustee to recover the payments. In short, you should not try to repay your parents, siblings, close friends or others before you file for bankruptcy because the Bankruptcy Court has the power to “avoid” or reverse the payment. This is called a preference, because the payments were made to creditors you may have preferred over another. In this context, the Bankruptcy Code calls your parents, siblings, other relatives and close friends “insiders.” 11 U.S.C. Sec. 101(31). Payments made to any creditors within ninety days of filing bankruptcy may be preferences, while payments to “insiders” will be scrutinized by the Trustee if they occurred within one year of the bankruptcy filings.
What if you’ve already paid?
What happens if you have already made such a transfer within the last year and now need to file for bankruptcy? The Trustee may file a lawsuit against the person who received the payment if he can show (1) the payment was on an antecedent (as opposed to current) debt; (2) the payment was made while the debtor was insolvent; (3) the payment was made to a non insider creditor, within 90 days of the filing of the bankruptcy (or to an insider within one year of filing); and (4) the payment allowed the creditor to receive more on its claim than it would have, had the payment not been made and the claim paid through the bankruptcy proceeding. The Bankruptcy Code permits a Trustee to recover such payments.
The policy behind this rule is to diminish the advantages that a creditor might get by litigation or by aggressive collection actions that force the debtor into bankruptcy. With respect to insiders, the policy is to prevent those closest to the debtor, who may have advance knowledge of the debtor’s financial distress, from gaining an advantage at the expense of other creditors who are “strangers.”
Defenses to a preference action
However, there are certain defenses to a preference action, see 11 U.S.C. 547(c). They include: contemporaneous exchanges; payments made in the ordinary course of the business of the debtor and the creditor on ordinary business terms; security interests that secure debts that bring new value to the debtor; and amounts of subsequent credit extended and unpaid. These defenses need to be raised in an answer to a preference complaint. The burden of proof lies with the creditor (the person or entity that received the payment) to establish that despite the elements of a preference, the transfer is protected by one or more of these defenses. In an insider preference action, there is no presumption that the debtor was insolvent when the payment was made (a necessary element of a preference claim) and thus the proof of these type of actions may be more difficult for the Trustee (although Trustees do frequently prevail).
If you or a family member is facing a preference action, consult a bankruptcy attorney as quickly as possible.