In my practice as a Colorado Springs Bankruptcy Attorney, it’s not uncommon for my clients to owe family members money they’ve borrowed in order to try and make ends meet. And, as long as they owe them money, that’s fine. We’ll just list the debt on their Bankruptcy Schedules and it will be discharged along with their other dischargeable debts. Then, after they get their Discharge, they are free to re-pay their relatives if they like. The problems arise when my clients pay back their relatives in the one year period before their bankruptcy case is filed.
Under Section 547 of the Bankruptcy Code, any debt repaid to an “insider”, like a family member, can be overturned or “avoided” by the Bankruptcy Trustee.
This is how it will typically occur:
The debtor borrows money from a family member. The debtor then comes into some money, either by getting a tax refund, a lump sum disability payment or something else. They feel obligated to their family member and don’t want to hurt them by filing bankruptcy “on the debt”. In addition, they’d prefer if their family member doesn’t know that they’re filing for bankruptcy. So, they pay them back and then file their bankruptcy case.
At the Creditors Meeting, the Trustee asks: “Have you paid back any family member, business partner or close friend any money within the last year?” The debtors answers: “Yes. I paid back my grandmother $3,000.00 a few months ago.” The Trustee then asks for the grandmother’s name and address. The Debtor wants to know: “Why?” The Trustee says: “So that I can contact her to get the money back.”
What the Trustee is doing is “avoiding the preference”. The idea behind the law allowing the Trustee to do this is that, in the eyes of the Bankruptcy Code, all Creditors should be treated like other similarly situated Creditors. By paying “insiders” and not paying credit cards, medical providers, etc., the debtor has given the insider preferential treatment. So the Trustee does his or her best to get the money back from the Insider in order to make the distribution of the money equitable for all similarly situated creditors. The basic idea is to make it fair for everyone who is owed money by the Debtor.
What can be done if you’ve already paid back a family member and are now looking to file for bankruptcy? You can:
- Hold off on filing your case until it has been more than one year since the payment was made; or
- You can make an agreement with the Trustee to pay that amount to him or her and avoid having them contact your family member for the payment.
As a Colorado Springs Bankruptcy Attorney, I’ve had clients opt for each of the above scenarios. Some have held off on filing their cases. Others have just bitten the bullet and made a deal with the Trustee to pay the money back. I can’t recall any letting the Trustee go after the Insider – that would cause too much trouble in the family.
Other non-Colorado Springs Bankruptcy Attorneys have also written about Bankruptcy “P” words: