Everyone has creditors they would rather pay back before others (such as debts owed to family or friends), but if you pay back these creditors prior to filing for bankruptcy they could be considered preferential debt payments. This would allow the bankruptcy trustee to recover any payments made in order to more evenly distribute it amongst all creditors.
What is a preferential debt payment?
A preferential debt payment is essentially any payment that benefits only certain creditors prior to filling for bankruptcy. If, for example, you were to pay back a loan you owed your friends business and then shortly there after file for bankruptcy, it would most likely be considered a preferential debt payment.
How long must you wait in order to avoid a preferential debt payment?
This will vary depending on your relationship with the creditor. For most creditors, any payments made within the 90 days prior to filling for bankruptcy would be considered a preferential debt payment. Three important things to note are that the payment must exceed $600, you must be insolvent at the time of payment, and the creditor must be receiving more than they otherwise would in a bankruptcy settlement in order for the payment to count as a preferential payment.
Close friends and family have even stricter terms. Payments made to this subset of people within 1 year prior to filling for bankruptcy would be considered a preferential debt payment. The same three requirements will still apply
What happens when a preferential debt payment occurs?
If, throughout the bankruptcy process, it is determined that a preferential debt payment occurred, the trustee can recover, or clawback as it is commonly refereed, the full amount paid.
It is important to note that this is not illegal, unless the payment was made with the known intent to defraud your other creditors or hide assets from the court. In most cases, the payment will simply be clawed back from any of the involved parties. The payment will then become part of the bankruptcy settlement.
How to avoid preferential debt payments?
The easiest way is to simply avoid having payments fall within the designated periods. This means you may have to avoid filling for bankruptcy until these payments have cleared the preferential period. You should not do this with the intent of defrauding your other creditors or in an attempt to hide assets though, or else you may risk charges for your actions. One way to avoid this confusion is to stick to a regular schedule for payments, as to avoid the appearance that these payments were made purposefully to favor one party over another.
This article should not be taken as legal advice. Yet, the information provided should help you decide whether you have given or received a preferential payment. If you believe you may have an issue, we suggest you seek the advice of a lawyer.