Specifically, if you pay a creditor more than you are paying to your other creditors before you file your bankruptcy, then that “favored” creditor may be required to give back that extra money so that it is shared among all the creditors. This is especially true if you are paying one creditor when you are no longer paying anything to anyone else. Your payment to your favored creditor is called a “preference”—you are considered to be paying that creditor in “preference” to your other creditors.
So your good intentions backfire. Your desire to be nice to that special creditor, who is often a family member, by paying off that debt and keeping it out of your bankruptcy case results in the opposite. Your favored creditor gets mixed up in your case when you probably didn’t want him or her even know about it. He or she has to give up the money you paid—and may have to come up with it even after having spent it. The trustee can sue him or her to get the money back. And afterwards, assuming that you feel a moral or family obligation to make that person whole, you would be paying that debt a second time after your bankruptcy is done.
The good news about this problem is that it can be avoided altogether if you get legal advice from an experienced bankruptcy attorney before you make the “preferential” payment or series of payments to that favored creditor. Or even if you’ve already made that payment when you see your attorney, there are often ways to get around it.
But I caution you that the law about preferences is complicated. Section 547 of the Bankruptcy Code can be pretty confusing. It’s about 1,318 words long, containing 56 sub-sections and sub-sub-sections. If you take a look at it, I think you’ll agree that this is NOT a do-it-yourself aspect of bankruptcy law.
So if there is a chance that you will need to file a bankruptcy, before you pay anything to a relative or any other kind of special creditor that you feel obligated to pay, first talk to an experienced bankruptcy attorney. Do so even if—in fact especially if–you don’t consider the person you’re inclined to pay to be a “real” creditor, because, for example, the debt was never put in writing, or nobody else knows about it. And most importantly, if you HAVE made such a payment before you see your attorney, absolutely be sure that you disclose this to the attorney, and do so at the beginning of your first meeting. It may well affect the timing of your bankruptcy filing.
Preferences are mostly a problem when they are discovered AFTER the case is filed. That’s what you want to avoid. Avoid that and most likely preferences will not be a problem for you.