It is common for people to pay back their family members for past debts owed to them instead of paying back other creditors, such as credit card companies and medical providers. This can be problematic because Minnesota law requires creditors be paid back equitably.
If you repay a family member, or close personal friend $600 or more within a year before filing for bankruptcy, this can be considered a “preferential transfer.” A preferential transfer occurs when you “prefer” certain creditors over others by paying them for past debts and not paying the other creditors.
Why Bankruptcy Law in MN Requires Equitable Creditor Payments
The law requires that all creditors be treated fairly and paying back some creditors, while ignoring others, gives the bankruptcy trustee the right to take action against the preferred creditors, and recover the amount they were repaid, so that the trustee may more fairly distribute the proceeds to the other unpaid, or underpaid, creditors.
This obviously creates a problem when the preferred creditors are family members to the debtor (the person who has filed for bankruptcy). The bankruptcy trustee has the right to sue family members for receiving preferential payments and some trustees will exploit this to coerce debtors into making big payments to them to settle the matter and avoid a lawsuit. If the debtor does make payments to their family members prior to filing for bankruptcy, there are some legal defenses that can be made to avoid the trustee being able to recover money from the family members.
Payments made in the Ordinary Course of Business
The first legal defense is that the payments were made in the ordinary course of business. Although this defense is more commonly asserted by businesses filing for bankruptcy, individual debtors may also assert it in certain circumstances. For example, if the debtor routinely made payments towards debts owed to family members, while also regularly making payments to other creditors (i.e. credit card companies), they could probably make a good argument that the payments made to family members were made in the ordinary course of business.
In other words, they were not special payments made in preference to the family members, but were instead routine payments made, along with payments to other creditors, that were not unfair to the other creditors. This defense is also more likely to succeed if the payments were being regularly made pursuant to an official written agreement between the debtor and the family member.
Contemporaneous Exchange as a Defense
A second common defense that can be made that the payments made to family members do not constitute preferential transfers, is that such payments were a “contemporaneous exchange for new value.” A payment that is made as a contemporaneous exchange for new value is one that is intended by both the debtor and family member to be a “new transaction.” In such a transaction, the family member provides something of value to the debtor with the mutual expectation that the debtor repay the family member within a short period of time thereafter. This is considered different from the debtor paying the family member for a past-due debt.
An example would be a family member of the debtor loaning the debtor $500 for groceries and the debtor repaying the family member as soon as they get their next paycheck a few days later. This would likely be considered a contemporaneous exchange for new value as the transaction was sufficiently contemporaneous (close enough in time between the loan and repayment) and the repayment by the debtor was in exchange for this new transaction, rather than repayment on an old debt. Bankruptcy law permits this kind of exchange to encourage creditors to continue to deal with needy debtors even when they cannot afford to pay their other old debts.
Re-Loan the Debt as a Defense
A third defense for avoiding the trustee from being able to take action against family members for repayment that could potentially construed as a preferential transfer, is to simply have the family member re-loan the entire amount of money that the debtor paid back before filing for bankruptcy.
However, the money that is loaned back to you must be an actual loan that you will be required to pay back to the family member, in good faith. It is advisable to ensure that this transaction is well documented via bank account statements, checks and/or receipts, and that it is understood by the family member that they will be listed as a creditor in the bankruptcy.
The bankruptcy trustee has the right to request records of all such transactions as well as the right to ask questions, under oath, of both the debtor and family member, if need be. In order for this defense to work, the debtor must have an ability to exempt (“legally protect”) the money re-loaned to them so that trustee cannot take it from the debtor to pay creditors.
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To determine what property will be protected in the bankruptcy, and whether you need to be concerned about a preferential transfer to a family member, you should seek the advice of an experienced bankruptcy attorney before filing bankruptcy. See us anytime at www.kainscott.com!
