What Does A Chapter 13 Trustee Do With A Preference?

A Chapter 13 trustee in Minnesota identifies and investigates preferential payments made by the debtor within a specific period before filing bankruptcy. If a preference is found, the trustee may seek to recover the payment for the benefit of creditors. This process aims to ensure fairness and equitable distribution of assets among all creditors.

When filing for Chapter 13 bankruptcy in Minnesota, it’s essential to understand the role of the bankruptcy trustee and how they handle your case. A trustee plays a critical part in managing the financial affairs of individuals who seek bankruptcy protection. One of their primary responsibilities is identifying and dealing with “preferences,” which refer to certain types of financial transactions made before filing for bankruptcy that could be undone.

If you're considering filing, it's critical to discuss your situation with a Chapter 13 bankruptcy attorney in Minnesota. Some basics about the trustee's treatment of preferences are also informative.

Understanding Chapter 13

Chapter 13 bankruptcy allows individuals to reorganize their debts and pay them off through a court-approved repayment plan, typically lasting three to five years. This differs from Chapter 7, which involves liquidating assets. Under Chapter 13 bankruptcy law, you keep your property, but the trustee ensures creditors receive what they are entitled to under the law. When it comes to preferences, the trustee will look closely at certain payments or transfers you made before filing, i.e., antecedent debt. The point is to determine if they unfairly benefited a specific creditor.

The trustee’s job is to ensure the bankruptcy process is fair for all creditors involved. If they find a preference, they may attempt to recover that payment to distribute it more evenly among your creditors. But what exactly constitutes a preference? And how does the trustee handle these situations?

Bankruptcy Code on Preferential Payments

One of the key roles of a Chapter 13 trustee is identifying and addressing preferential payments. The Bankruptcy Code has strict guidelines about these payments to prevent debtors from giving preferential treatment to certain creditors. Let’s break this down further.

What Is Preferential Payment in Bankruptcy?

A preferential payment in bankruptcy refers to a payment or asset transfer made by the debtor to a creditor before filing for bankruptcy, giving that creditor more than they would receive under the bankruptcy process. In other words, if you paid off a significant debt to a friend, family member, or a specific creditor shortly before filing for bankruptcy, this could be seen as unfair to your other creditors.

To determine whether a payment is preferential, the trustee will consider several factors, such as the timing of the payment, the amount, and the creditor involved. If a payment is deemed preferential, the trustee can recover the funds and redistribute them fairly to all creditors.

Preference Claims

A trustee can make a preference claim under the Bankruptcy Code if they identify that a payment or transfer meets the criteria of a preferential payment. Preference claims are designed to ensure fairness and equality among creditors, preventing any one creditor from being unfairly advantaged over others before the bankruptcy filing.

In many cases, the trustee will file an action with the court to recover the preferential payment. These claims can involve various forms of payments, including cash payments, property transfers, or even paying off secured debt. Once the payment is recovered, the trustee will include it in the debtor’s estate, which will then be distributed according to the Chapter 13 repayment plan.

Different Elements of Preferential Payments

To determine if a transfer qualifies as a preferential payment, the trustee looks for specific elements:

The payment must have been made to a creditor: The transfer benefits a creditor, meaning the debtor was repaying or giving an asset to a party to whom they owed money.
The payment was made within a certain period before filing: Typically, preferential payments are those made within 90 days of filing for bankruptcy. For insiders, such as family members or business associates, this period extends to one year.
The debtor was insolvent at the time of the transfer: Insolvency means that the debtor was unable to pay all their debts as they came due.
The creditor received more than they would have in a Chapter 13 case: The trustee must show that the creditor received more through this payment than they would have if the payment had been handled under the normal bankruptcy process.

Creditor Defenses

When a Chapter 13 trustee identifies a preferential payment, creditors may have defenses available to protect themselves from having to return the payment. The defenses available depend on whether the creditor is a regular creditor or an insider creditor, as the Bankruptcy Code treats these two types of creditors differently. Understanding these defenses is critical for creditors who receive payments prior to a bankruptcy filing.

Regular Creditors' Defenses

Regular creditors, or those who are not closely associated with the debtor, can raise several defenses to a preference claim. One common defense is the "ordinary course of business" defense. If the payment was made in the regular course of business between the debtor and the creditor, and in accordance with their prior dealings, the payment may be protected. For instance, if a debtor consistently paid a vendor within 30 days of receiving invoices and continued to do so before filing for bankruptcy, the vendor might argue that the payments fall within the ordinary course of business.

Another defense is the "new value" defense. If the creditor provided new goods or services to the debtor after receiving a preferential payment, the payment might not be subject to recovery. This defense encourages creditors to continue doing business with financially distressed individuals or businesses without fear that payments will be undone.

Insider Creditors' Defenses

Insider creditors, such as family members or business partners, face greater scrutiny when it comes to preferential payments. The Bankruptcy Code allows trustees to look back up to one year for payments made to insiders, as opposed to the 90-day lookback period for regular creditors. However, insider creditors can still defend against preference claims. One defense is proving that the payment was not made as a result of favoritism, but rather as part of an arms-length transaction. For instance, if a debtor repaid a personal loan to a family member under terms similar to those offered by a bank, the family member might argue that they were not receiving preferential treatment.

In either case, raising a valid defense against a preference claim requires providing documentation and evidence of the nature of the transaction. Creditors who believe they may be subject to a preference action should seek legal advice to protect their rights.

How Far Back Can the Bankruptcy Trustee Look for Preferential Transfers?

A common question for debtors is how far back the Chapter 13 trustee can look when investigating preferential payments. Under the Bankruptcy Code, the trustee has the right to scrutinize transactions that occurred before filing, but the timeframes vary depending on the type of creditor involved.

Ordinary Creditors

For ordinary creditors, the trustee can look back 90 days before the bankruptcy filing. If a debtor made a payment to an ordinary creditor during this period that gave them preferential treatment, the trustee can take action to recover that payment.

Insider Creditors

“Insiders” include family members, business partners, or close associates. The trustee has the power to look back as far as one year with respect to insider creditors. This extended period allows the trustee to investigate any transactions that may have unfairly benefited individuals with a closer relationship to the debtor.

The purpose of these look-back periods is to prevent debtors from manipulating their financial affairs in the lead-up to bankruptcy by favoring certain creditors, whether intentionally or unintentionally. If the trustee identifies any preferential payments within these timeframes, they will seek to undo those transactions for the benefit of all creditors.

Bankruptcy Trustee Undoing Certain Financial Transactions

When a Chapter 13 trustee identifies preferential transfers, their next step is to take action to recover or “undo” those transactions. This process is known as avoidance, and it allows the trustee to bring the funds or assets back into the bankruptcy estate so they can be fairly distributed among creditors.

How Does the Trustee Undo Preferential Transfers?

The trustee typically files a lawsuit in bankruptcy court to avoid the preferential transfer. This legal action is known as an adversary proceeding, and it gives the court the authority to order the return of the transferred assets or funds. Once the transfer is undone, the recovered amount is pooled into the debtor’s estate, which is then divided according to the Chapter 13 repayment plan.

For example, if a debtor repaid a personal loan to a family member three months before filing for bankruptcy, the trustee could file an action to recover that payment. Once recovered, the funds would be used to pay off creditors more evenly, ensuring no one creditor benefits at the expense of others.

Impacts on the Debtor

It’s important to note that preference claims don’t necessarily mean the debtor did something wrong. Instead, these rules are in place to promote fairness. Debtors who unknowingly made preferential payments should be aware that the trustee’s role is to maintain an equitable distribution of assets and may take action to recover those payments.

How Much Time Does a Preferential Payment Take?

In a Chapter 13 bankruptcy case, the trustee has a specific timeframe within which they can pursue a preferential payment action. Understanding the timeline of preference claims is important for both debtors and creditors, as it impacts the recovery and distribution of assets in the bankruptcy estate.

A Chapter 13 trustee can pursue a preference action up to two years from the date the bankruptcy petition is filed. This means that if the trustee identifies a preferential payment during the case, they have two years to file a lawsuit in bankruptcy court to recover the funds. However, the trustee must also adhere to the lookback periods defined by the Bankruptcy Code. As mentioned earlier, regular creditors are subject to a 90-day lookback period, while insider creditors are subject to a one-year lookback period.

It’s worth noting that the trustee does not have to wait until the end of the two-year period to take action. If a trustee identifies a potential preferential payment early in the bankruptcy case, they can initiate the avoidance action relatively quickly. However, the debtor or creditor involved may request additional time to gather evidence and defend against the claim.

How to Protect a Family Member or Friend From a Preference Avoidance Action

One of the most concerning aspects of preference claims for debtors is the potential impact on family members or friends who have received payments before the bankruptcy filing. If you repaid a personal loan to a relative or close friend before filing for Chapter 13, the trustee may pursue a preference action to recover those funds. However, there are ways to protect your loved ones from being drawn into the bankruptcy process.

The best way to protect a family member or friend from a preference action is to structure payments to insiders in a way that avoids triggering the trustee’s scrutiny. For example, it’s important to ensure that any payments made to insiders are documented, and that they resemble the terms of a regular, arms-length loan. If you agree to repay a personal loan to a family member under terms that are similar to those you would receive from a bank (i.e., regular monthly payments with interest), the trustee may be less likely to view the payment as preferential.

Additionally, spreading out payments to insiders over a longer period of time may help avoid triggering the preference rules. For example, rather than repaying a family loan in one lump sum shortly before filing for bankruptcy, it may be better to make smaller payments over time. This can reduce the risk of the payment being deemed preferential.

A Chapter 13 Attorney Can Assist with Your Bankruptcy Filing in MN

By understanding the defenses available to creditors, the timelines for preference actions, and the exceptions to the preference rules, both debtors and creditors can better protect themselves during a Chapter 13 bankruptcy case in Minnesota. For debtors concerned about preferential payments, consulting with a local bankruptcy attorney can help ensure that financial transactions are handled in accordance with the law, while minimizing the impact on family members, friends, and creditors.

Don't let bankruptcy overwhelm you. With guidance from LifeBack Law, you can discover options to eliminate debt and rebuild your life. Schedule a free consultation today by visiting us online or calling 320-252-0330.

FAQs

Who gets paid first in cases of bankruptcy?

In Chapter 13 bankruptcy, secured creditors are generally paid first, followed by priority unsecured creditors. General unsecured creditors may receive a portion of their debts through a Chapter 13 repayment plan.

What is the lookback period for preferential transfers?

The lookback period for preferential transfers varies depending on the relationship between the debtor and the creditor. For insiders, the lookback period is one year. For non-insiders, it is 90 days. This is not to be confused with the two-year period during which a bankruptcy trustee can pursue a preference action.

What is a preferential payment?

A preferential payment is a payment made by a debtor to a creditor within a specific period before filing for bankruptcy. The payment is considered preferential if it gives the creditor an advantage over other creditors.

What are the defenses to a preference claim?

There are several defenses to a preference claim, including:

Subsequent new value: If the creditor provides new value to the debtor after receiving the preferential payment, it may reduce or eliminate the preference claim.
Ordinary course of business: If the payment was made in the ordinary course of business between the debtor and creditor, it may not be considered preferential.
Contemporaneous exchange: If the payment was made in exchange for contemporaneous new value, it may not be preferential.

How many days the US trustee looks back to see if a payment is a preference payment to an insider?

The US trustee looks back one year to determine if a payment is a preference payment to an insider.