The decision to file a bankruptcy is one of the hardest decisions that some people will make. Once this decision has been made, many people want to “clear up” some debt. Usually, they want to take care of Mom, Dad, Brother, Sister, Best Fried etc… The reasoning is that they were kind enough to lend you money when you needed it the most, so we want to make sure they get paid back. Many people use their tax returns to pay back someone close to them – and they do it right before they file for bankruptcy!
This is a bankruptcy no-no! All of the people mentioned above are “insiders” and they should, in no circumstances, EVER be paid back before a bankruptcy is filed. Because these people are insiders, the bankruptcy court has the power to “avoid” the payment. They have the power to reverse this payment and make whoever you paid give the money back. A payment to an insider before the filing of a bankruptcy is a preference. Basically, you have preferred that person over every other creditor you owe and the theory is that you only paid them back because they are close to you – which is true! Who would anyone rather pay back – a family member you see every day or a credit card company?
In the ninety days before the filing of a bankruptcy, payments made to any creditors are preferences and may be subject to being avoided or reversed by the Trustee. But not all payments will fall into a preference category. Payments on mortgages, rent, utilities, car payments and certain loans within the ordinary course of business will fall outside of the preference requirements. All the people mentioned above are “non-insiders.”
“Insiders”, while being a preference, have a different look back period, which is one year. If you have made a payment to an insider prior to the filing of your bankruptcy, make sure your attorney is aware of this payment. The attorney can advise you on how best to protect your family member/friend. If you haven’t made a payment yet, but are thinking about it, DO NOT DO IT. Remember, a bankruptcy is going to get rid of your legal obligation to pay, but not an ethical one. After your bankruptcy is complete and you are discharged, you can pay back whomever you want. What you do not want is to pay back your family member or friend before bankruptcy, have the Trustee sue them and take the money back, and then have to repay them all over again!