Repaying Loans to Family Members prior to filing Bankruptcy

Frequently I meet with people seeking Chapter 13 or Chapter 7 bankruptcy protection who are surprised that the actions they take prior to filing for bankruptcy can have a lasting impact on their bankruptcy. For instance, let’s say the debtor’s mother “helped her out” by loaning her money for several months. Later on the debtor comes into some money and repays the family member in full but then subsequently has to file for bankruptcy protection.

Two bankruptcy provisions come into play in this situation. First, Sec. 547 allows the Trustee to avoid any transfer of an interest of the debtor in property made within 90 days before the filing of the petition or up to one year prior to the filing if the transfer was made to an insider. So that means if Debtor wants to file Chapter 7 , the price of admission is that she understands the Trustee can and will recover that money from the mother for the benefit of the creditors she is trying to discharge. The law will not allow the debtor to pay off her mom in full when other unsecured creditors would receive nothing in Chapter 7, which brings me to the second provision which comes into play if the debtor files a Chapter 13. According to Sec. 1322, a Chapter 13 repayment plan cannot discriminate unfairly against any class of creditor, i.e., paying the mother in full while the other unsecureds get zip. Furthermore, Sec. 1325 states that a Chapter 13 plan cannot even be confirmed unless the unsecured creditors received at least what they would have received under a Ch. 7, in this case, that would have included the amount of the preferential transfer.

So, that seemingly harmless repayment can become a can of worms in a bankruptcy setting. Invariably the debtor asserts that they didn’t know they were going to file at the time of the payment, they don’t want their family member involved and that it’s “not fair”. Those may be valid points, however, they won’t get you out of the preferential transfer quagmire.  That doesn’t mean you won’t be able to file Chapter 13 or Chapter 7 if you have repaid loans to friends or family members, however, if you have and need to file bankruptcy, discuss the matter with your attorney.  An experienced bankruptcy attorney will know how to properly advise you how to address the payments in your bankruptcy.

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