Bankruptcy is a powerful tool that enables thousands of Minnesotans to deal with, and eliminate, overwhelming debt, every year. In exchange for the debtor (what you call a person who files for bankruptcy) receiving this tremendous benefit, the bankruptcy court has an obligation to make sure all creditors are treated fairly.
For this reason, Section 547 of the bankruptcy code specifically prohibits debtors from unfairly paying back some creditors more than other creditors. Unfairly paying one, or more, creditors more than other creditors is known as a “preferential payment.”
Payments to an “ordinary” creditor totaling $600, or more, in the 90 day period prior to the debtor’s bankruptcy case being filed may constitute a preferential payment. Ordinary creditors are considered typical creditors, such as credit card companies, medical providers, and banks who provide personal loans, for example, whom do not have a special relationship with the debtor. If the creditor is considered an “insider” of the debtor, payments to that creditor totaling $600, or more, may constitute preferential payments if the payments were made within the one year period prior to the debtor’s case being filed. Although the bankruptcy code specifically defines insiders as relatives or business partners of the debtor, the bankruptcy courts have ruled that whether a person is an insider depends upon the exact nature of the person’s relationship with the debtor. So, a close personal friend, for example, who is not related to the debtor, nor engaged in business with the debtor, may be considered an insider depending on the circumstances.
Section 547, in the interest of fairness to creditors, gives the trustee the right to legally pursue any preferential payments against the receiving creditor through either an informal demand, or through a formal legal action called an “adversarial action” which is essentially a lawsuit to recover the preferential payment from the creditor. The trustee’s responsibility is then to collect the excess money paid to the creditor and distribute it more fairly amongst the other creditors. While the average debtor likely does not care whether the trustee pursues preferential payment against an ordinary creditor, it is much more likely they will have an issue with the trustee going after their family members to recover the money.
However, even if the debtor has repaid a debt owed to a close friend or family member in excess of $600 in the one year period before their case is filed, a legal defense can sometimes be made to prevent the trustee from collecting against that person. Section 547 itself provides two such primary defenses against preferential payment collection actions by the trustee.
First, the trustee may not pursue a preferential payment if the payment was a “contemporaneous exchange for new value.” In layman’s terms a contemporaneous exchange for new value occurs if the money paid to the creditor was not for an old debt (aka an antecedent debt) but given to the creditor in exchange for something new. For example, if the debtor owes their father $3,000 for car repairs that occurred two years prior to their case being filed, but pays the father $800 for new tires a month before filing bankruptcy, this transaction would not be considered a preferential payment, because the $800 was paid for new tires, not for the old debt.
Second, money paid to a creditor in the “ordinary course of business” cannot be pursued by the trustee as a preferential payment. Basically, this applies when the debtor regularly makes payments to the creditor in a usual and regular fashion, and typically, also makes payments to their other creditors. In the same example, if the debtor had been making regular $200 monthly payments to their father for the $3,000 loaned by the father for the car repairs, and also, made regular minimum payments to their other creditors in a similar fashion, the trustee would also likely not be allowed to go after the father to recollect those payments.
Payments on debts to family members is common but can often be handled in a way that minimizes the negative impact that the payments will have on the family members, or the debtor themselves (i.e. the debtor can settle with the trustee or simply wait until after the one year preference period has expired to filed their case).
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To best make sure oneself and their family members are best protected in a bankruptcy, one is always well-advised to first consult with an experienced bankruptcy attorney. LifeBack Law Firm PA has such experienced attorneys, and now, has a new office located in the historic Cathedral Hill neighborhood at 370 Selby Ave., Suite 224, Saint Paul MN 55102. Come visit us there, or online, at lifebacklaw.com!
