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Thinking of filing bankruptcy? Resist the urge to repay personal debts

Paying back certain creditors over others before bankruptcy is a bad idea.

Some people struggling with debts borrow money from friends or family members to help tide them over during a difficult time. As a result of their gesture of kindness, some feel a moral obligation to pay back these kinds of debts, even if it requires the last bit of cash to do so. Although this is no doubt a noble sentiment, if the person later files for bankruptcy, their gesture could be all for not, because it could be regarded as a preferential transfer.

About preferential transfers

Under the bankruptcy laws, all filers must treat all of their creditors equally. Pursuant to this requirement, the bankruptcy trustee will examine all financial transactions made during a certain period before the bankruptcy was filed. This is done to make sure that the filer did not favor one creditor over another.

A preferential transfer occurs when a bankruptcy filer significantly favors one creditor over another before the bankruptcy was filed. In many of these cases, the preferred creditor is a family member, friend or business associate. However, it is not necessary for the filer to have a personal relationship with the creditor in order for a preferential transfer to occur. The bankruptcy laws define a preferential transfer as:

• A transfer made to a creditor for a debt owed;

• Made within 90 days before the date bankruptcy was filed (or one year before if the creditor fits the definition of an “insider”);

• Made while the filer was insolvent (it is presumed that the filer is insolvent 90 days before the filing date); and

• Which allowed the creditor to receive more than they would have received had the filer filed Chapter 7 bankruptcy

In Chapter 7, most unsecured creditors-creditors holding debts not secured by collateral-receive little or nothing. Because of this, most transfers made three months before the filer files bankruptcy are considered to be preferential. If the filer transferred money to an “insider” (includes family members and business associates), the same is true for transfers within a year before the filing date.

The fate of preferential transfers

Under the bankruptcy laws, the bankruptcy trustee is empowered to seek out and void any preferential transfers. This allows the trustee to seek repayment of the transfer from the creditor. Once the funds have been recovered, the preferential transfers are added to the bankruptcy estate to be distributed to the creditors according to the law.

Fortunately, not all transfers made just before bankruptcy are preferential, as the law carves out several exceptions. For one, payments for alimony, child support and domestic support are not deemed preferential under the law. Also, if the aggregate amount transferred to the creditor is $600 or less, it is generally not considered preferential.

Speak to an attorney

Because of the preferential transfer laws, it is better to wait to repay favored creditors once bankruptcy has been completed (although you are under no legal obligation to do so). If you are struggling with debts that you have little hope of paying back, speak with the experienced bankruptcy attorneys at Coan, Lewendon, Gulliver & Miltenberger, LLC. Our attorneys can work to ensure a smooth passage through the bankruptcy process, obtaining the fresh start that you are seeking as soon as possible.