Credit Preference Payments: How to Avoid Them in Your Consumer Bankruptcy

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You have probably never heard of a “preference payment” in a Chapter 7 consumer bankruptcy proceeding, but these are never fun conversations to have with a client.  Let me write about this now and hope that, if you decide to hire me as your attorney, we will never have to have this conversation.  This situation comes up when an otherwise broke person has a sum of money on hand, and then has to decide what to do this money.

Payments to creditors with ninety days of your bankruptcy filing

The filing date of a Chapter 7 bankruptcy petition is just that – the day upon which your bankruptcy petition was filed with the court.  It is an important event, the case number is assigned, your court hearing date is assigned, and the filing fees are paid.  This becomes the date the Chapter 7 Trustee is assigned as well.  The Chapter 7 Trustee is a court official appointed by the United States Department of Justice to review your petition, schedules and related documents.  Among other things, the Trustee will examine which of your creditors you paid in the 90 days prior to the filing date.  Assuming you made normal, regular payments, or perhaps that you did not pay any creditors at all, there won’t be anything for the Trustee to be concerned about.

When I say “creditors,” I mean credit cards, medical bills, mortgages, car notes, people who you borrowed money from or received services from with an expectation of repayment.  This is a different concept from the idea of monthly bills like utilities, food, rent and the like, because instead of borrowing money and the repaying it, monthly expenses involve paying for things as you go.

The Bankruptcy Code, 11 U.S.C. § 547

In the language of the bankruptcy code, the trustee has broad powers to “undo” payments that were made in the 90 days prior to the bankruptcy filing date, or perhaps as long as one year before the filing date.  A “preference” payment is defined in the bankruptcy code as a payment made:

  • To or for the benefit of a creditor
  • For or on account of an antecedent debt owed by the debtor before such transfer was made
  • Made while the debtor was insolvent
  • Made

 

  • on or within 90 days before the date of filing of the petition; or
  • between 90 days and one year before the date of the filing of the petition, if such creditor at the of such transfer was an insider; and

 

  • that enables such creditor to receive more than such would receive if –

(the transfer had not been made)

 

To put this in context, let’s say that a consumer receives a large amount of money, thousands of dollars, before the bankruptcy is filed.  This could be from a winning lottery ticket, a bonus check at work, an income tax refund check, or a successful business transaction.  The consumer decides that, despite the receipt of this money, their overall picture is so bleak that a consumer bankruptcy filing is indicated.  In fact, they set aside part of the money to pay the attorney and the filing fees for their bankruptcy.  But they also decide that it is only fair to pay $2,000 back to Uncle Joe, who has been lending them money for the past year while they were struggling financially.

Then, they go a see their attorney to file for bankruptcy relief.  Their attorney has the unpleasant task of explaining to them that their Trustee will now contact Uncle Joe to get their $2,000 payment back.  The money will not go back to them, however, it will be re-distributed to all the creditors so that each one gets a small percentage of the payment.

The Reason Behind the Rule

Think of it this way, the other creditors’ reaction to the money the consumers decided to pay to Uncle Joe is, essentially, “What the heck?”  After all, the consumers borrowed money from them, too.  And they got paid nothing, while Uncle Joe got $2,000.  Adding insult to injury, then the consumers filed bankruptcy, claiming that they did not have money to pay their debts back.  This is in fact the classic “preference” scenario.  This comes about during income tax refund time more than at any time during the year, in my practice anyway.

There are defenses to trustee preference recovery actions listed in the bankruptcy code.  If you are facing a trustee preference action, hire an attorney to see if one or more of the defenses would apply.  But let me suggest that the best course of action is to avoid this situation completely, and it is normally possible to avoid with the assistance of a consumer bankruptcy attorney.  In fact, you should get an attorney to represent you as soon as you realize that you are facing overwhelming debt.  Delaying the inevitable will not help your cause.  And certainly if you come into a windfall lump sum of money as you are contemplating debt relief through a bankruptcy filing, consult with your attorney about what do to with that money to avoid a trustee preference claim.  Remember, the trustee can go back one (1) year on payments made to insiders, like family members, or business partners.

This is merely a brief review of the concept of a preference payment.  Many other situations could arise, and you should not take action based upon this brief review without an attorneys’ assistance.  Call me today at 216-642-8234 to discuss your situation, the first consultation is free.

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