Do Not Pay Your Family and Friends Back Right Before You File

Last time, we discussed how you should not use your credit cards or request balance transfers before filing bankruptcy.  Today, we’re going to talk about why you shouldn’t pay back your friends and family right before you file. Above all, the Bankruptcy Code espouses fairness, and it simply isn’t fair to pay back only some creditors at the expense of others.  Generally, any creditor who receives more than they would have received under a Chapter 7 liquidation within 90 days of the debtor filing bankruptcy will be subject to an avoidable preference action.  A preference action is initiated by a law suit filed by either the debtor-in-possession in a Chapter 11 case or the Trustee in a Chapter 7 case.  This action is called an “adversary proceeding”, and its purpose is to force the creditor who was paid off within 90 days of the bankruptcy petition being filed to return the property to the trustee to be fairly disbursed to unsecured creditors.

But Wait, Family and Friends Count as “Insiders”

While your typical creditor will be able to keep whatever money or property transferred the debtor transferred prior to the 90 days before the petition is filed, a debtor’s family and friends fall into a specially segregated category called “insiders” under the code.  Under Section 547 of the Bankruptcy Code, the Trustee may “avoid” any transfer of money or property to an insider made within one year of filing.  Yes, you read that correctly.  Even if you decide to pay back your sweet grandmother the money she loaned you 11 months ago, the Trustee in Atlanta can file a law suit against your grandmother in bankruptcy court to take back that money.  If you had paid off a credit card or medical bill 11 months ago instead of your grandmother, that money or property would not be subject to an avoidable preference (the Trustee would not be able to take the money back). However, to avoid the possibility of a debtor taking advantage of the bankruptcy process by favoring friends and family to the detriment of creditors, Congress separately classified those closest to you (including business partners) to insulate creditors from fraudulent practices by unscrupulous debtors.

Unfortunately, not every transfer was made with the intent to defraud a creditor, even if that transfer was to a person categorized as an “insider”.  But that’s how the law works.   Some 16 year-old kids are clearly not ready to get behind the wheel, while a precocious 14 year-old could be perfectly capable of driving in Atlanta traffic. The law is overinclusive to some and underinclusive to others.  Congress has to draw the line somewhere, and that arbitrary point in time is one year prior to the date the petition is filed.