Crucial Question: Is It OK to Pay a Special Creditor Before Filing Bankruptcy to Keep It Out of the Bankruptcy Case?

Not a good idea. If you do your friendly creditor may have to turn over to the trustee whatever you paid it. So it won’t be so friendly.

If your intention is to pay off a favored creditor so that this creditor is no longer involved in your bankruptcy case, your plan could easily backfire. Here’s why.

“Preference” Law

A “preference” or “preferential” payment is one you make to a creditor during a certain period of time before filing bankruptcy and meets certain conditions.

If during the 90-day period before you file bankruptcy you make a payment to a creditor while you are insolvent (your total debts exceed your total assets), then after you file bankruptcy your bankruptcy trustee can “avoid” that payment, requiring the creditor to pay to the trustee the payment you’d earlier made to that creditor.

If during the one-year period before you file bankruptcy you make a payment to a creditor who is an “insider,” while you are insolvent, then after you file bankruptcy the trustee can “avoid” that payment, requiring the creditor to pay it over to the trustee. The definition of “insider” is vague, generally including relatives, friends, and business associates, but for practical purposes it can include anybody who you’d have any reason to favor over other creditors.

So with regular creditors, payments made in the 90 days before filing bankruptcy are the only ones in play. While for “insiders,” payments made in the full year before filing bankruptcy are in play.

The $600 and $6,225 Safe Harbors

If you paid any single creditor a total amount of less than $600 during the period in question (one year for an “insider” creditor or 90 days for an ordinary creditor), then the trustee cannot pursue that creditor for the money.

This $600 amount applies to consumer bankruptcy cases, ones in which the total amount of consumer debts exceed the total amount of business debts (if any). In a business case, in which the business debts exceed the consumer debts, the amount of protected payments is much larger—$6,225.

No Bad Intention Required

Whether a payment made to a creditor is a preference or not does not turn on any particular intent on your part, such as an intent to favor that creditor over the others. Instead the law just accepts as a reality that if you paid a creditor while you were insolvent during the pertinent 1-year and 90-day periods, the effect was preferential regardless of your actual intent.

Practicalities

If you really care about your creditor and having him or her keep whatever you paid, having the trustee “avoid” your payment and make your creditor “return” the money to the trustee can be a major hassle.

The creditor, instead of being glad about having gotten paid off or having gotten at least partially paid, will very likely be very unhappy about needing to fork over the money he or she had gotten from you many months earlier. If you’d paid off the creditor in full, it may well not have even known about you filing bankruptcy afterwards. Avoiding the embarrassment of this creditor knowing about your financial problems may have even been part of your motivation in paying it off.  

Also, the creditor in all likelihood long ago spent the money you paid, so now for him or her to come up on short notice with the money demanded by the trustee may be a significant headache. Obviously your desire to make things as easy as possible for this creditor gets turned upside down.

And if you paid the creditor out of a deep sense of family or moral obligation, you may even feel compelled to pay him or her a second time to make up for the payment(s) the trustee takes back.

On the other hand, you may no longer care all that much about the creditor to whom you made a preferential payment. You may have since had a falling out with this person, if, for example, you could not keep up the required payments, or if you are discharging (forever writing off) the rest of your debt to him or her. Then you may not care one way or the other whether or not your bankruptcy trustee pursues the creditor for the payment(s) you made.

Or you may simply believe that you did your best to fulfill your obligations to this person, and now you just have to let the chips fall where they may. You didn’t know anything about preference law and its unfortunate consequences for the creditor, you have a clear conscience, and cannot worry about something that is after all at this point totally outside your control.

Related posts:

Crucial Question: Can I Exclude a Creditor from My Bankruptcy Case? Crucial Question: How Can I Use an Unprotected “Non-Exempt” Asset to My Benefit Even Under Chapter 7 “Straight Bankruptcy”? Crucial Question: In a Chapter 13 Case, How Do You Keep Collateral That’s Not a Home or Vehicle? Crucial Question: In a Chapter 7 Case, How Do You Keep Collateral That’s Not a Home or Vehicle? Crucial Question: Is it OK to Sell or Give Away Some of My Possessions Before Filing Bankruptcy?