Bankruptcy preference payments are debts you paid shortly before filing that favored one creditor over the rest. A trustee can generally recover payments made to ordinary creditors within 90 days of filing, and payments to insiders, such as relatives or business partners, within one year. The money is recovered from the person you paid, not from you.
That last point is what worries most people. You borrowed from your sister in Dublin or your parents in Danville, and paying them back first felt like the decent thing to do. Bankruptcy law sees it differently, and the consequences fall on the family member. If you have repaid a relative recently, or are thinking about it, it is worth calling (415) 754-0115 to talk with a bankruptcy attorney before any more money changes hands; you can also reach us through our contact page.
Why bankruptcy preference payments can be reversed
Bankruptcy is built on equal treatment among creditors of the same type. If you owe several unsecured creditors and, on the eve of filing, pay one of them in full, that creditor has jumped the line. Section 547 of the Bankruptcy Code lets the trustee undo that advantage so the money can be shared among everyone entitled to it.
Nothing about this assumes you did anything dishonest. A preference can be completely innocent. The law is about fairness between creditors, not punishing the person who filed.
The elements a trustee looks for
- A transfer of your money or property to, or for the benefit of, a creditor.
- Made to pay a debt that already existed, rather than for something received at the same time.
- Made while you were insolvent. For the 90-day period, insolvency is presumed.
- Made within the look-back period.
- Leaving the creditor better off than it would be in a Chapter 7 distribution.
The two look-back periods
Ordinary creditors: 90 days
Payments to banks, credit card companies, medical providers and other arm's-length creditors are reviewed for the 90 days before filing. For individuals whose debts are mainly consumer debts, payments to a single creditor that add up to less than a small minimum set in the Code are not recoverable, and a separate minimum applies to debts that are not primarily consumer debts.
Insiders: one year
For insiders, the window stretches to a full year. Insiders include relatives by blood or marriage, general partners, and corporations or LLCs you control. Paying back a parent, an adult child, a sibling, an in-law or your own company within the year before filing is the classic situation that leads to a clawback.
What counts as a payment to family
It is not only cash. Handing over a car to settle a loan from your brother, transferring a paid-off asset to a parent you owe, or paying a relative's credit card because they lent you money can all be treated as transfers on account of a debt.
Payments that usually are not preferences
Everyday bills are generally safe. The Code includes defenses and exceptions that protect common transactions:
- Ordinary-course payments. Regular monthly bills paid on normal terms, such as utilities, rent, a car payment or a mortgage payment.
- Contemporaneous exchanges. Paying for goods or services at the time you receive them.
- Domestic support. Child support and alimony payments are protected.
- Secured debt within collateral value. Payments on a fully secured loan often do not improve the lender's position.
What happens if a trustee finds a preference
In Chapter 7
The trustee typically sends a demand letter to the relative or creditor who received the money, asking for repayment to the bankruptcy estate. If that fails, the trustee can file a lawsuit in bankruptcy court, known as an adversary proceeding. The recovered funds are distributed to all creditors, and the relative then becomes one of your creditors in the case.
In Chapter 13
Chapter 13 cases often handle a preference differently. Rather than suing the relative, the trustee commonly factors the value of the preference into the liquidation analysis, meaning your plan may need to pay unsecured creditors more to account for it. That can raise your monthly payment.
What to tell your attorney, and why honesty protects you
The official Statement of Financial Affairs asks directly about payments to creditors in the 90 days before filing and payments to insiders in the prior year. You sign it under penalty of perjury. Leaving out a payment to a family member is far more dangerous than the preference itself, because concealment can lead to denial of your discharge and potential criminal exposure.
Bring your attorney the following:
- Every payment to a relative, friend or business partner over the past year, with dates and amounts.
- Any written or informal loan terms with those people.
- Large payments to any single creditor in the past 90 days.
- Any property you gave or sold to someone you owed.
With the full picture, an attorney can evaluate whether a payment actually qualifies as a preference, whether a defense applies, how the chapter you choose affects the outcome, and whether the timing of the filing is a factor worth discussing. These questions come up regularly in the Chapter 7 and Chapter 13 bankruptcy cases The Somal Law Firm handles for families in Pleasanton, the Tri-Valley and the wider Bay Area. It helps to also understand what the trustee does with the rest of your property; our guide to California bankruptcy exemptions covers that side.
Frequently asked questions
Will I get in trouble for repaying my parents?
Repaying family is not a crime or fraud on its own. The concern is that the trustee may recover the money from them. Disclosing the payment accurately is what protects you.
Can I pay my relative back after I file?
Voluntarily repaying a discharged debt after your case is generally permitted, as long as it is truly voluntary and not coordinated in a way that hides assets during the case.
Does a preference problem stop me from filing?
Usually not. It changes the strategy and sometimes the timing, which is why it should be discussed before filing rather than after.
If you have paid back someone close to you, do not wait for a trustee's letter to find out what it means. Call (415) 754-0115 to schedule your free consultation, or share the details through our contact page, and we will walk through how the payments are likely to be viewed and the options available to you.
Attorney Advertising. This article is general legal information for Bay Area residents, not legal advice, and does not create an attorney–client relationship. Every situation is different — please consult a licensed attorney about your specific circumstances.