Be Careful Who You Pay When Struggling Financially
A family must make tough choices when money is tight. Cutting back on expenses, doing without, making lower cost substitutions, and delaying payments to creditors are all tactics to stretch a family’s budgets until things get better. Often creditors are prioritized, so the family doctor gets paid, while a credit card payment may get postponed.
Repaying a loan to a friend or family member before filing bankruptcy can create issues in your case. The Bankruptcy Code allows the trustee to avoid payments to “insider” creditors made within a year of the bankruptcy filing date. Insider creditors are relatives, general partners, partnerships in which the debtor is a general partner, directors, officers, persons in control, affiliates, and insiders of affiliates of the debtor. The trustee can sue an insider creditor and force the return up to one year of these payments.
Not every payment to an insider creditor can be avoided. Section 547 of the Bankruptcy Code describes payments that can be avoided as “preference payments. They include:
1. A transfer
of an interest of the Debtor in property;
2. to or for the benefit of a creditor;
3. for or on account of an antecedent debt owed by the Debtor before such transfer was made;
4. made while the Debtor was insolvent (the Debtor being presumed to be insolvent within the 90-day period preceding the filing of a petition); and
5. made within 90 days before the filing of the bankruptcy petition (or within one year if the creditor was an insider); and
6. that enables the creditor to receive more than such creditor would have received in the case were a Chapter 7 liquidation proceeding.
If you have made a preference payment to an insider creditor, there may be defenses. The three most commonly used in an individual bankruptcy are: the Ordinary Course of Business Defense, the Contemporaneous Exchange Defense, and the Small Commercial Preference Defense.
Ordinary Course of Business. In order to prevail with this defense the debtor must show that the debt was incurred in the ordinary course of business between the two parties, was paid according to the ordinary course of business between the two parties OR paid according to ordinary business terms as are customary in the industry.
Contemporaneous Exchange. This defense centers on when the preference payment was received. A preferential transfer may not be avoided if it was intended by the debtor and the creditor to be, and in fact was, a contemporaneous exchange for new value given to the debtor and the antecedent debt of the creditor was not affected by the debtor’s payment. An example of a contemporaneous exchange is a purchase situation: you pay your mother $2,000 and she gives you her car.
Small Commercial Preference Defense. Section 547(c)(9) of the Bankruptcy Code limits transfers could be avoided in a commercial case (currently amounts less than $6,225). This section specifically provides, “if, in a case filed by a debtor whose debts are not primarily consumer debts, the aggregate value of all property that constitutes or is affected by such transfer is less than [$6,225].” This section applies to an individual debtor who does not have primarily consumer debts.
The bottom line is this: preference issues are complex. Don’t turn over money requested by the trustee until your attorney advises you to do so.