Bankruptcy and Repayment of Debts Owed to Relatives

Occasionally there is a need to borrow money from relatives. Regardless of the size of the loan, the obligation to repay the debt to a family member is usually pretty powerful. Most people try to repay those debts first, before paying their other creditors. However, if you are experiencing financial problems, repaying your relatives prior to filing bankruptcy is not a good idea. As discussed below, any such loans can be repaid, but they should be repaid after the bankruptcy is filed.

The reason that the debtor should not repay debts owed to relatives prior to the filing is because of the “insider” problem. Your relatives, especially close ones, are considered to be “insiders” under the Bankruptcy Code’s definition of an insider, which includes a “relative of the debtor.” 11 U.S.C. § 101(31).

Because they are related to you, any payments to insiders within the applicable period are treated as preferences. The Bankruptcy Code states that a “preference” occurs when:

the debtor transfers something “to or for the benefit of a creditor;”
for a debt “owed by the debtor before [the] transfer was made;”
“made while the debtor was insolvent” (that is, the debtor’s debts were greater than his assets);
made within 90 days of bankruptcy, or, if an insider receives the transfer, within one year of bankruptcy; and
and the transfer “enables [the] creditor to receive more than [the] creditor would have received” (1) in a Chapter 7 case, (2) than “if the transfer had not been made,” and (3) “the creditor received payment of such debt to the extent provided  in the [Bankruptcy Code].”

Generally, according to the Bankruptcy Code, creditors of the same type, called “class” should be treated the same.  Because of this, the Bankruptcy Code looks back anywhere from 90 days to one year for preferential transfers or “preferences.” The Code presumes, not incorrectly, that a debtor would rather pay a relative rather than other creditors like credit card issuers.

As a result, the bankruptcy trustee will examine any debts repaid during the preference period. If the trustee believes a preference occurred and there are no defenses, the trustee can sue the person or entity who received the payments.

Because of these rules, you should hold making payments to the relatives prior to the filing. You can always pay back those debts after your bankruptcy case is over.

If you’ve already paid your relatives back during the one-year preference period, there are some solutions. First, if the payments are under $600, the trustee can’t sue your relative for the payments, since the preference falls within the “small preference” exception.  Also, if the payments are $600 or more, but not that much–say not more than $1,000, the trustee still might decide not to bother with the transfer since the cost of recovery and administrative costs would reduce the benefit to the bankruptcy estate.  Trustees don’t like administering bankruptcy estates where the asset values don’t justify the cost and effort of administration.

Another defense is that those payments may be “ordinary course” payments.  In other words, it may be normal in both the relative’s financial affairs and the debtor’s to borrow and repay the money, and the money was paid back in accordance with agreed-upon terms.  This is called the “ordinary course of business” defense.

The third available defense is that the relative gave “new value” in exchange for the payment.  For example, the relative made another loan or gave you something else of value in return.

The fourth approach to addressing this problem, is if the preference occurred close to a year prior to the time in which you plan on filing your bankruptcy, you can simply wait out the year.

Finally, the transfer can be undone by having the relative refund the money. Unfortunately, this may create another problem that relates to the availability of cash exemption in the bankruptcy filing.  If you can exempt the refunded money, you may repay the debt after your case is over.

If you contemplating filing Chapter 7 Bankruptcy or Chapter 13 Bankruptcy, or are dealing with debt problems in Western New York, including Rochester, Canandaigua, Brighton, Pittsford, Penfield, Perinton, Fairport, Webster, Victor, Farmington, Greece, Gates, Hilton, Parma, Brockport, Spencerport, LeRoy, Chili, Churchville, Monroe County, Ontario County, Wayne County, Orleans County, Livingston County, and being harassed by bill collectors, and would like to know more about how bankruptcy may be able to help you, contact me today by phone or email to schedule a FREE initial consultation with a Rochester, NY, bankruptcy lawyer.

Related Posts
  • Changes to New York's Bankruptcy Exceptions Read More
  • Top Five Things Not To Do Before Filing Bankruptcy Read More
  • Bankruptcy Planning, Debt and 401(k) Read More