When people begin to have financial trouble, one place they often turn to for help is to family and friends. Family and friends can be a big help is alleviating short term financial problems. Borrowing money this way can be quick, free of interest, and often have very reasonable repayment terms. It can be a great short-term solution. But, sometimes borrowing money from family and friends doesn’t fix the problem. If there are serious financial problems, these loans from family and friends just add to the debt load. When the debt load becomes too great, bankruptcy becomes an option, and that’s when loans to family and friends become a problem.
In a bankruptcy case, all debts have to be listed in the paperwork that is filed with the court. Most people don’t want to include family or friends on the list of creditors, so they conveniently forget about the debt or they pay the debt back. Either of those choices creates a problem. Not listing the debt is providing false information to the court, and repaying the debt creates a preference.
A preference is a payment to a creditor that allows that creditor to be treated better than other similar creditors that are going to be discharged in the bankruptcy case. In other words, it’s not fair that one creditor gets paid and the others do not. This is especially true if the one creditor that gets paid is family or friends. The court wants all creditors to be treated the same, and if family and friends get paid and credit cards and medical bills do not, those payments are a preference. Payments of this nature can be reviewed up to a year prior to filing if the payments are to friends and family.
The consequence of a preferential transaction is that the bankruptcy Trustee can reverse the payment. That means the payment can be recovered from the person or company that was paid. This section of the code defeats the purpose of trying to pay family and friends back prior to filing bankruptcy. The money that is recovered is then divided up between all of the creditors listed in the case, in an effort to treat the all the same. Obviously, this creates a problem. Most people who file bankruptcy don’t want their family and friends to owe money to the Trustee. So, some planning is sometimes necessary in order to avoid creating a preference.
The easiest, and legal, way to protect family and friends is to simple pay them back after the bankruptcy has been filed. Since that payment is post-petition, it cannot be recovered by the Trustee. It is still important to list those creditors in the bankruptcy, but payments made after the bankruptcy has been filed are not subject to the Trustee’s recovery powers. It is a simple solution to what can be a complex problem when it comes to bankruptcy.
By Addam Fera