Avoiding the "Preference" Problem

 Posted on April 17, 2017 in Bankruptcy Law

Prevent your trustee from giving you a big headache if you paid a debt to a friend or relative during the year before filing bankruptcy.

In our 3 blog posts last week we explained “preferences” in bankruptcy. In particular, in our last one on Friday we showed how a “preference” claim by your trustee could cause you a significant problem. Doing something seemingly sensible before filing bankruptcy could cause trouble during your bankruptcy case. Today is about how to avoid that trouble.

Avoid the Risk of a “Preference”

A “preference” is a payment you make to one creditor in preference to your other creditors when you’re on the brink of filing bankruptcy. Specifically, it only involves payments made during the 90-day period before that filing. That period expands to the full year before filing if the creditor you pay is a friend, relative, or business associate.

Those 90-day and 1-year look-back periods are fixed, non-extendable. There is a straightforward way to take advantage of this. Just don’t pay anything you owe to a favored creditor during these periods of time. If you owe anything to a friend or relative, don’t pay them anything if there is any possibility that you’ll be filing bankruptcy in the following year. And don’t pay any other favored creditor during the 90-days before filing.

Otherwise you risk that your bankruptcy trustee will require the person you paid before filing to “return” that money to the trustee after you file bankruptcy.

The Realities of Life

There are situations that simply not paying that favored creditor is not that simple.

First, you may feel great pressure to make that payment. You owe some money to a relative who really needs you to pay some or all of it back. He or she trusted you and you feel duty-bound to show that you are trustworthy. Or your friend that you owe really needs the money now. Or you may want to pay in order to avoid including that debt in your bankruptcy case. You may not want to legally write off that debt. You may want to avoid having that friend or relative ever knowing about your anticipated bankruptcy filing. So if you are able to pay, it can be hard not to.

Second, you often don’t know whether and when you are going to file bankruptcy. Most people put it off because they understandably hope that they can avoid it. So being told to not pay a personally important debt in the one-year or 90-day periods before filing can be quite impractical advice.

Maybe sometimes, but not always. Just because you hope not to file bankruptcy, and don’t know when you will if you do, doesn’t mean you don’t know when you’re in financial trouble. If you are, be very cautious about paying a debt to a friend or relative. If you realize that doing so can cause you and the other person a major headache, you may find a better alternative.

Getting Advice

Your bankruptcy lawyer can hugely help in this. You can find out whether it is your best interest to be filing bankruptcy, now or in the near future. You can find out the best solution for dealing with your special creditor.

People understandable avoid seeing a bankruptcy lawyer until they feel that they have to file a bankruptcy case. But that is often not wise, because often the sooner you get advice the better. There are usually ways of meeting your needs that you didn’t realize. As the saying goes, knowledge is power. That’s true about your financial life in general, and in avoiding a possible “preference” as well.

Delay the Bankruptcy Filing

If you’ve already made a preferential payment, it may be worth waiting before filing bankruptcy. As mentioned above, those 90-day or 1-year look-back periods before filing your bankruptcy case are fixed. If you paid your grandmother $1,000 360 days ago when you got your tax refund, it’s usually easy enough to wait a week before filing so that payment is not within the year before filing. Then it’s not a “preference” and won’t be a problem.

If it isn’t already obvious, it’s crucial to be honest and thorough with your lawyer about any such payments you made. It’s easy to not think of debts to friends or relatives are real debts, them as real creditors. You may have paid in something other than money. Frankly, it may seem sensible to just pretend it didn’t happen.

But if you’re up-front with your lawyer there are usually solutions much better than not telling the truth. For example, most payments to creditors, including favored creditors, do NOT qualify as a preference. There are a number of elements that must be met for a payment to be legally a “preference.” See our blog post of a week ago for more about that. You may be worried about something not worth worrying about. There are many parts to your financial life and a good lawyer will help you find the best way to meet your goals.

You want to avoid creating a “preference.” Get legal advice so that you can do so and not worry about this.