Bankruptcy and the Holidays: Watch Out for “Preferences”

The holiday season is a time to be nice. But don’t do so by paying relatives & friends what you owe them if you are considering bankruptcy.

 

Paying Your Favorite Creditor Before Filing Bankruptcy

If you owe a friend or relative or some money, you may be more motivated to pay all or part of that debt during the holiday season. The person may really need the money. And may be urgently asking for it. Or even demanding it.

And you may be more able than usual to pay it. You may have gotten an annual bonus from work. Or have received a little Christmas money from a sympathetic relative or friend.

But if you try to be nice and you do pay this kind of debt, you may end of being more naughty than nice.

It’s Worth Knowing—What Is a “Preference”?

A “preference” is a confusing concept. It only arises in a small minority of bankruptcies, but can cause a major headache when it does. They can usually be avoided, making them all the more worthwhile to understand.

Since both the need and the ability to make a “preferential” payment may be greater during the holiday season, that’s all the more reason to understand what it is.

The “Preference” Rule

If during the 365 day-period BEFORE filing a bankruptcy case you pay a creditor more than you are paying at that time to your other creditors, then AFTER your bankruptcy is filed that favored creditor could be forced to surrender to your bankruptcy trustee the money that you had paid to this creditor.

The idea is that people in financial trouble should be discouraged from playing favorites among their creditors for a certain period of time before filing bankruptcy, in order to help promote one of the most important principles of bankruptcy law: legally equal treatment of the creditors.

A Holiday Example

Imagine that you owe your mother $1,000 from two years ago when you were desperate for money to pay your mortgage or rent. You were supposed to make monthly payments to pay her off within a year, but just didn’t have any money to spare so you hadn’t paid a cent. She really, really needs and wants the money. Fortunately you got a $650 annual bonus on December 1, a couple hundred dollars as a holiday gift from your favorite uncle, plus scraped together the rest of the money. So with great relief a couple of weeks ago you paid off the whole $1,000, and never felt so good paying off a debt.

But then a few months later when you file a bankruptcy case, your trustee would very likely require your mother to pay that $1,000 to the trustee. If she had already spent the money, she would have to come up with $1,000 somehow. Once she did so, that $1,000 would be divided among your creditors by the trustee.

The Harsh Reality of “Preferences”

So instead of you coming across as you intended—responsible and considerate to your mother (or other favored creditor)—the result is the opposite.

You wanted to pay off that debt and fulfill your moral obligation. You may have even wanted to keep the debt out of your bankruptcy case, perhaps in part so that your mother did not to know about you filing bankruptcy.

But instead your mother—or any similarly favored creditor—gets mixed up in your bankruptcy case, and does so in a way potentially quite embarrassing to you and harmful to her. She has to give up the money you paid her months earlier, or more likely having to scramble to come up with it somehow after having spent it.

Then after all this, given that your mother is again out $1,000, you may well continue to feel that you have a family or moral obligation to make good on that debt. So you end up paying that debt to your mother a second time, after your bankruptcy is over. Clearly not a good result! That would be true regardless whether it’s your mother, some other family member or close friend, your family doctor… whoever was your favored creditor.  

Be a Grinch, and Don’t Pay Your Mother (Friend, Doctor)

The good news is that this mess can be avoided altogether. Just, if at all possible, don’t pay your favored creditors anything during the year before filing. That one-year look-back period only applies to “insiders,” basically anybody who you would have a personal or business reason to favor. The look-back period is otherwise only the 90days before filing.

But to distinguish between insider and non-insider creditors, and to get through this entire minefield safely, you definitely should get legal advice from an experienced bankruptcy attorney. Of course it’s better to do so before you make the preferential payment(s) to your favored creditor. But even if you’ve already made the payment(s), see an attorney because there are often workable ways to solve this problem.

Finally, if you are tempted to try this without an attorney, take a look at the statute on the subject:  Section 547 of the Bankruptcy Code. It’s a real head-scratcher. About 1,300 words long, it has 56 separate parts to it. Definitely something to let an experienced professional handle for you. 

 

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