Make your bankruptcy trustee work for you by retrieving your recent payments to, or garnishments by, creditors–to your benefit.
Our last 4 blog posts have been about “preferences” in bankruptcy. The last two have focused on how your trustee’s “preference” claim could cause significant problems, and how to avoid them. But you can also use “preference” law to your advantage. Today we get into how to do so.
The Big Picture
Imagine that you are under serious financial pressure, maybe thinking of filing bankruptcy, maybe trying hard to avoid doing so. Then you get threatened with a lawsuit by a debt collector if you don’t start making payments on its debt. So you somehow squeeze some precious money out of your way-overstretched budget and pay a chunk of the debt. Or instead you were sued earlier and the creditor just grabbed a big part of your paycheck or checking account. Maybe you’ve had to suffer through a number of these payments or garnishments.
Wouldn’t it be nice if, after being forced into bankruptcy anyway, you were able to get that money back? Wouldn’t it be nice to be able to put that money to better use?
Under certain circumstances bankruptcy’s preference law can accomplish this.
You actually need two sets of circumstances. First, the money paid to the creditor has to qualify as a “preference.” Second, you need to owe a particular kind of debt that you want or need to get paid.
Payment(s) Qualifying as a “Preference”
A “preference” is an extraordinary aspect of the bankruptcy system. In general, filing a bankruptcy case creates a bright line between what happened before that moment and what happens afterwards. Between “pre-petition” events and “post-petition” ones. So, generally the assets that your bankruptcy case deals with are those in existence at the time of filing. And to a very limited extent, bankruptcy also pays attention to post-petition assets. But for most purposes what you owned before filing isn’t part of the bankruptcy picture.
However, in a few limited situations the bankruptcy system is allowed, indeed required, to look backwards from the filing date. “Preference” payments are one such situation. Under certain circumstances, payments you made, voluntarily or involuntarily, during the 90 days BEFORE filing can be undone. They are “undone” not by you but by your bankruptcy trustee.
The trustee’s job is to gather assets to distribute to creditors. If a payment a creditor received during the 90 days before filing qualifies as a “preference,” the creditor is forced to pay that money back, handing it over to the trustee. The trustee then takes that money and distributes it to your creditors under a legally prescribed priority system.
(The preference look-back period goes back a full year as to certain special creditors. Basically this includes creditors with whom you have a close personal or business relationship. But we are focusing today only on the 90-day look-back period. That’s because those are the creditors whose “preference” payments you’d more likely want undone.)
The Elements of a Preference
In order for the trustee to get back a payment you paid to the creditor in the 90 days before the bankruptcy filing that payment must meet a number of elements. Two of those elements tend to be the most important:
- At the time you made the payment you were insolvent. (See Section 547(b)(3) of the U.S. Bankruptcy Code.)
- That payment resulted in the creditor getting more than it would have in a Chapter 7 bankruptcy distribution had the payment not been made. (Section 547(b)(5) of the Bankruptcy Code.)
These two elements are often quite easy to meet.
First, “insolvent” is defined in the Bankruptcy Code (Section 101(32)) as the “financial condition such that the sum of such entity’s debts is greater than all of such entity’s property.” Most consumers contemplating bankruptcy are likely insolvent under this definition. (The biggest likely exception if for homeowners who have a meaningful amount of equity in their homes.) If your combined debts are greater than your combined assets, you meet this “insolvent” element.
The second element is even more likely met. It involves a comparison between the amount of the payment made to the creditor and the amount the creditor would have received in a bankruptcy liquidation. In most consumer bankruptcy “liquidation” cases creditors receive nothing for two reasons. First, everything or near everything the consumer owns is “exempt,” protected from bankruptcy liquidation. So there is nothing to distribute, no liquidation. Second, even if there are some assets to liquidate and distribute it all goes towards administrative costs and “priority” debts. So nothing trickles down to the creditor in question. Since the creditor would have gotten nothing in a bankruptcy liquation, the entire amount it received in payment qualifies as “preferential.”
Imagine that Creditor X garnished $1,000 out of your checking account right after you deposited your tax refund. You file bankruptcy case a month later.
You are a consumer debtor whose debts have exceeded the amount of your assets for at least the past two year. So you were insolvent at the time of the garnishment.
The assets that you do have are all covered by the property exemptions available to those filing bankruptcy within your state. Therefore Creditor X would have received nothing in a Chapter 7 distribution.
Since both of those elements are met, the full $1,000 garnishment received by Creditor X is a “preference.” Your bankruptcy trustee could require Creditor X to send that $1,000 to him or her. If this creditor would fail to send it voluntarily, the trustee could sue to require the creditor to pay the $1,000.
The $600 Safe Haven for Creditors
There’s one last twist if your debts are “primarily consumer debts.” Then your bankruptcy trustee may not require a creditor to pay back a payment if “the aggregate value” of the payment(s) “is less than $600.” See Section 547(c)(8).
The Preference Doing You Some Good
At the beginning we referred to two things necessary for a preference to do you some good. First, the payment has to qualify as a “preference.” We’ve covered that.
And second, you need to owe a particular kind of debt that you want the trustee to pay, a debt that you’d otherwise have to pay out of your own pocket. It’s a lot better to have the trustee pay it out of money you’d already paid to another creditor, and put it to good use.
We’ll cover how this second part works in our next post (this coming Friday).