When Paying Your Debts Can Cause Trouble
Many tough decisions are made when a family is struggling with debt. Often debts are paid according to priority. Those bills at the lowest priority may not get paid at all. While this may be a good strategy under ordinary circumstances, it may back-fire when a bankruptcy is imminent.
The act of paying one creditor while ignoring another is called a preference payment by the bankruptcy laws. The debtor preferred to pay one creditor and not others. A preference payment is defined as a transfer of money made before a bankruptcy filing, to pay on a pre-existing debt, made while the debtor is insolvent, and gives the creditor more than it would receive from the liquidation of the debtor’s assets during a Chapter 7 bankruptcy.
In deciding who should get paid first, the Bankruptcy Code divides creditors into classes and creates a hierarchy of preferences. For instance, the Bankruptcy Code prefers that child support is paid before credit cards, and that a secured car payment is paid before a medical bill. In many cases a pre-bankruptcy preference payment is perfectly fine; in other cases it can create trouble for the debtor and the creditor. This is especially true when one creditor in a class receives more than other creditors in the same class, or a creditor in a lower class receives money before creditors in higher classes.
When a preference payment occurs within 90 days of the bankruptcy filing, the bankruptcy trustee can ask the court to order the preferred creditor to turn over the payment(s) for distribution according to the hierarchy of preferences. This period is increased to one year if the creditor is an “insider” creditor. An “insider creditor” is generally a relative, business partner, etc. who has a special relationship with the debtor.
Common preference payment scenarios include:
1. Repaying a personal loan from a family member just before filing bankruptcy;
2. Paying one business vender, while ignoring others.
3. Transferring a credit card balance from one card to another.
4. Paying off a credit card, medical bill, or personal loan just before bankruptcy.
When the trustee requests turnover of a preference payment, the creditor is faced with either complying with the request or litigating the matter in bankruptcy court. There are legitimate preference payment defenses which largely depend on the circumstances of the payment. However, the general practice of bankruptcy trustee is to sue first and ask questions later.
If you are struggling financially, seek out legal advice early and avoid making mistakes with preference payments. An experienced bankruptcy attorney can help you make wise financial decisions and avoid preference payment situations.