The short answer is “no,” but there’s some good news, too. Before we jump into the options you do have for making things right with a friend or family member when you file bankruptcy, let’s look at the general rules for repayments leading up to a bankruptcy filing and how “insiders” are treated differently.
Bankruptcy is designed in part to make sure creditors are treated fairly. That doesn’t always mean they get paid in full–or at all. But, it does mean the bankruptcy petitioner can’t pick and choose, routing all or a disproportionate share of funds to a specific creditor and leaving the others out in the cold. That’s true even if the creditor is your mom. It’s fairly common in Mississippi to see family members financially assisting other family members according to Ed Woods at Bond Botes & Woods, P.C. in Jackson, Mississippi. When initially consulting with someone about their financial problems, Mr. Woods makes a detailed inquiry to determine if a prospective client has been involved in any such transactions.
“It’s crucial to know the details about these situations before any formal bankruptcy petition is filed,” Mr. Woods said.
In fact, when the creditor is a family member or business partner, the transaction gets a bit of extra scrutiny.
Creditor Preferences in Bankruptcy
To help ensure that creditors are treated fairly in bankruptcy, the bankruptcy trustee looks back at transactions in the 90 days leading up to the bankruptcy filing. Of course, the court expects that you’ll have made some payments during that time. What the trustee is looking for is payments that give the creditor more than they would have received in a Chapter 7 case if you hadn’t made the payment.
For illustration, imagine that a Birmingham resident pays off a creditor with a $1,000 payment one week before filing. Like most Chapter 7 cases, it’s a “no asset” case. That means the unsecured creditors don’t get anything. But, if that $1,000 payment hadn’t been made, the $1,000 would have been available to pay creditors. Other creditors would have received a share of that $1,000.
Of course, this is a very simplified example. An experienced bankruptcy attorney is the best source of information about how specific payments may be treated in a Chapter 7 case. But, the example illustrates the core issue: by making a lump-sum payment to one creditor, the bankruptcy filer has potentially taken money away from other creditors.
If that’s the case, the bankruptcy trustee may avoid that transaction and take the money back for distribution to creditors. Mr. Woods says that the bankruptcy trustees in Mississippi take a very pragmatic approach to avoidance, especially where the amount that could be recovered is only a few hundred dollars. However, if the amount involved is significant, Mr. Woods advises that you must seek the advice of an experienced consumer bankruptcy attorney.
Special Rules for Insiders
Family members are considered “insiders” in a bankruptcy case. For bankruptcy law purposes, a relative includes:
- Great grandparents
- Great grandchildren
- Nieces and nephews
- Aunts and uncles
This includes people in those relationships as a result of a step-relationship or adoption.
The main difference that makes is that instead of looking back at transactions in the previous 90 days, the trustee can look back a full year. So, if your mom loaned you $5,000 to buy a car and you paid her back all at once nine months before your bankruptcy filing, the trustee may be able to reclaim those funds.
Obviously, having the bankruptcy trustee initiate an action against your mom to take back money that may be long gone is a far worse outcome than having delayed payment or made small payments over time.
Other insiders subject to the one-year lookback period include:
- A general partner of the debtor
- The relative of a general partner of the debtor
- A partnership in which the debtor is a general partner
- A corporation of which the debtor is a director, officer, or person in control
The Exception to Avoidance
The trustee’s right to avoid preferential payments made in the 90 days or one year preceding bankruptcy is intended to prevent the debtor from picking and choosing who gets paid. So, the rule only applies if the debtor was insolvent at the time of the payment. In simple terms, “insolvent” means that the bankruptcy filer’s debt exceeded his or her assets. Without crunching the numbers, a person wouldn’t necessarily know whether he or she was legally insolvent. Don’t assume that just because you were earning money and paying your bills at a given time, you weren’t insolvent. Talk to your bankruptcy attorney.
The Good News about Debt to Friends and Family
You can’t push your friends and family to the front of the line and pay them off before bankruptcy. And, you must list all of your outstanding debts in your bankruptcy petition, even if those debts are to insiders. But, in a Chapter 7 case, the bankruptcy estate includes only your assets at the time of filing. With limited exceptions (such as an inheritance), you’re free to do as you like with your income after the bankruptcy petition is filed–and that includes making payments to friends and family, even if they were listed in the bankruptcy petition.
While the automatic stay prevents creditors–even those close to you–from pursuing payment, it doesn’t prevent you from making voluntary payment of your own initiative. And, though the bankruptcy discharge eliminates your legal obligation to pay a debt, it in no way prohibits you from doing so.
The best way to protect yourself and those you may want to pay is to talk to an experienced bankruptcy attorney and disclose everything. A simple mistake could be costly for you and the friend or family member you’re trying to protect.
At Bond & Botes, we’ve been helping people legally resolve debt for decades. If you’re in Alabama, Mississippi or Tennessee and considering bankruptcy, you can schedule a free consultation right now. Just call 877-581-3396 or fill out the contact form on this page.
Ed Woods is the Managing Attorney of several of the Bond & Botes Law Offices throughout Mississippi. He holds a Bachelor of Science from the University of Southern Mississippi, and a Juris Doctorate from Mississippi College School of Law. Ed puts his extensive knowledge of bankruptcy law to use defending consumers from debt collection lawsuits and more. Read his full bio here.