It’s happened dozens of times. Here’s the scenario: I’m siting in a client meeting discussing finances and bankruptcy when my client tells me that he recently repaid his mom, dad, sister, mother-in-law, or some other close family member a large debt. When I explain that the Bankruptcy Trustee may sue his [insert family member here] his jaw drops, and there is silence. Then there is anger and disbelief.
“What do you mean the Trustee is going to sue my mother?! It was a legitimate debt. She helped me through a really rough time. I just cashed my tax refund check and gave it to her. What’s the big deal? Why is this relevant?!”
The reason it’s relevant is that repaying mom, or any other relative, prior to filing bankruptcy triggers a peculiar law known as a “preference.” A preference is a repayment- in whole or in part, in cash or in kind- to a creditor before filing bankruptcy that allows the creditor to receive more than she would have if the bankruptcy had been filed and she hadn’t been paid. It can be avoided, a legal term which essentially means “undone.” Still confused? It’s okay. This is an odd area of the law. Here’s another way of looking at it; if you repay a creditor before filing bankruptcy, then the Trustee may have a duty to get the money back.
The idea of a preference has its roots in simple fairness. When someone owes debts that he can’t pay, he shouldn’t favor one creditor over another. So, a bankruptcy Trustee has the power to make a creditor who received a preferential payment turn it over so that it can be redistributed fairly to all of the creditors. With normal “non-insider” creditors (banks, businesses, professionals, etc.), the Trustee can seek return of debt payments made within 90 days prior to bankruptcy. However, with insiders (family members, business partners, and others with similar close ties to the debtor), the lookback period is a year. So, repayments made to Mom within a year before filing bankruptcy can be set aside.
This means that if you owe your mom $3000 and you are thinking about paying her and also thinking about filing bankruptcy, you should talk to a competent bankruptcy lawyer first. A lawyer can give you some options and explain the law of preferences as they apply to your case.
At Kight Law Office, PC, we have been advising people and businesses about preferences for over a decade. I have helped people come up with good alternatives and helped people navigate solutions when they’ve paid a family member before first consulting with me. If you owe money to a relative, call us and let us give you your options.