Payments Before Bankruptcy May Be Recovered as an Avoidable Preference
For many people in debt, filing bankruptcy is not the first attempt at fixing their financial situation. Some people put their head in the sand. Others try to make minimum payments for a while. Still others try moving money around with a complicated network of balance transfers. But sometimes when a debtor has paid a creditor shortly before filing bankruptcy, the bankruptcy trustee will be allowed to get the money back. sometimes when a debtor has paid a creditor shortly before filing bankruptcy, the bankruptcy trustee will be allowed to get the money back. This is called an “avoidable preference.” Trustees are allowed to “reverse” the payment because the bankruptcy process is supposed to treat all creditors fairly.
It’s not an uncommon situation. A consumer may be carrying too much debt when they get an offer in the mail to transfer balances from one credit card to another, most often with a very favorable interest rate. Soon that favorable interest rate often explodes to over 20 percent. Then the debtor is right back where he started.
Avoidable preferences could be payments in the form of money or transfers of other property, such as vehicles, real estate or something else. There are two main categories of avoidable preferential transfers. One is for payments made to insiders and the other is for payments made to creditors who are not insiders.
An “insider” is just what it sounds like, a relative, friend, or business partner. The bankruptcy trustee has the power and authority to reverse any transfers of property of more than $600 to insider creditors if the transfer was made within one year of the date of the initial bankruptcy filing. This rule typically only applies to payments to creditors. This means that giving a payment to pay back a debt to a sibling may be avodable, but giving a gift to a friend is not. That doesn’t mean that giving away assets to insiders is a good idea prior to bankruptcy. It could invoke other problems with the court if the gift was made to defraud creditors.
The other category of avoidable preferences is for payments made to non-insider creditors, like credit cards. The trustee can only reverse the transfer the debtor paid the creditor more than $600 total over the previous 90 days prior to filing the bankruptcy petition.
It is important to note that the debtor will not be penalized if there is an avoidable preference. The trustee simply takes back the money from the creditor. But that could be an embarrassing or uncomfortable situation if the trustee calls a sibling to demand the money back. If the debtor doesn’t want the trustee to come after the money, then it may be advisable to wait to file bankruptcy until the time period elapses. Obviously, this is a case-by-case situation that requires analysis specific to the facts at hand.
There are other rules and exceptions that involve timing of insolvency of the debtor, but those questions are best left to an experienced bankruptcy attorney in Sacramento, CA. It’s a really good idea to seek counsel if these are issues that may come up in your bankruptcy or someone you know is struggling with debt.