While bankruptcy provides debtors with the benefit of a fresh start, the process is also designed to treat all creditors fairly. Almost all debtors have certain debts they would rather pay back before others (such as loans from family and friends). But if you pay back a loan from your family prior to filing for bankruptcy, the bankruptcy trustee may be able to treat it as a preferential transfer (also called a preference) and get the money back for the benefit of your creditors.
In general, whether the trustee can avoid a payment as a preference depends on:
To learn more about how to plan ahead for your bankruptcy, visit our Prebankruptcy Planning topic area.
Paying back a loan from family shortly before bankruptcy is the classic example of a preferential transfer. But in some situations such a payment is not preferential. Whether the trustee can avoid the transfer and get the money back for the benefit of your creditors depends on numerous factors. Here’s how it works.
For more information on preferences, see What Is a Preferential Debt Payment in Bankruptcy?
A payment (or transfer) to a creditor is considered a preference if it:
If the payment qualifies as a preference, the trustee can avoid the transfer and get the money back for the benefit of all creditors. In addition, be aware that bankruptcy law presumes debtors are insolvent in the 90-day period prior to filing for bankruptcy.
If you make a payment to a creditor who is an insider, the rules are even stricter. Instead of being able to avoid transfers made in the 90 days before bankruptcy, the trustee can avoid payments to insiders made within one year of the bankruptcy. Insiders include your relatives, your general partner, the relatives of your general partner, partnerships in which you are a general partner, and corporations of which you are an officer, director, or a person in control.
This means that if you pay back a loan from your family within one year prior to filing your case, the trustee may be able to avoid the transfer and get that money back if all other preference requirements are satisfied.
If you have already paid back a loan from your family, consider delaying your bankruptcy until a year or more has passed since the payment. If you don’t, you will need to disclose it in your bankruptcy paperwork and give the trustee an opportunity to recover the money and distribute it among your creditors.