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The Surprising Benefits: Solving an Uncomfortable “Preference” Problem

April 16th, 2018 at 7:00 am

A preferential payment to a relative or friend can turn very uncomfortable. But there are some good solutions. One should work for you.

 

Last week’s blog post introduced an uncomfortable problem: preference payments to a friendly creditor. (If you haven’t already please read that one before reading further here.)

The Solutions

We ended that blog post by listing and giving short descriptions of 4 likely practical solutions. We explain the first two of them today and the other two next week.

1. Wait to File Until after the 1-Year or 90-Day Preference Look-Back Period:

There’s one very simple way to avoid having money you paid to a favored creditor turn into a problematic preference.  Wait to file your bankruptcy case long enough so that enough time passes since that payment. Then it’s no longer a preferential payment that the trustee can cause you problems with.

The preference period is only 90 days with most creditors, but a full year with “insider” creditors. Without getting unnecessarily technical, there’s a good chance that anybody you’d have a personal reason for paying is an insider. See Section 101(31) of the U.S. Bankruptcy Code for the statutory definition of insider. But note that this is not a complete list. It says what the term “includes,” but courts have made clear that others not on the list could be insiders. For example, also included could be friends or others who’d you’d have a personal reason to favor over other creditors.

Whether the creditor is an insider or not, the payment you made is not a preference if more than 90 day/1 year has passed when your bankruptcy lawyer files your case. Then your bankruptcy trustee would have no power to require your payee to pay back your payment.

We are well aware that waiting is not a simple solution if you are in a big hurry to file your bankruptcy case.  Waiting even a few days may not be at all easy if your paychecks are being garnished or you’re under other similar collection pressure. Or waiting may even be totally inappropriate if your home would be foreclosed or your vehicle repossessed in the meantime.  

However, there are many situations where you would not be a huge hurry to file your case. Then waiting would be worthwhile. This may especially make sense if you are getting close to 90 day or 1-year mark since your preferential payment. So, at least look into whether you should just wait long enough to avoid the problem altogether.

2. Persuade Trustee Not to Pursue the Preferential Payment:

Just because there was a preferential payment within the look-back period, doesn’t mean it’s worth for the trustee to pursue. There are many circumstances in which you could help convince him or her to let it alone.

First, the simplest situation is if so little money is at issue that it’s not worth the bother. It takes some effort for a trustee to force a preferential payee to pay back the money. There is also a certain amount of paperwork and effort to divvy up the money among your creditors.  If the payment you made is no more than several hundred dollars most likely your trustee will shrug it off. (This is similar to trustees generally not chasing an unprotected (“nonexempt”) asset: if it’s only worth a few hundred dollars it’s usually not worth collecting and distributing.) Talk with your bankruptcy lawyer about what that unstated threshold dollar amount would  be in your area.

Caution: IF the trustee is already collecting assets in any form in your case, this threshold amount consideration likely goes out the window. If the trustee already has to liquidate anything and distribute money to creditors, he or she will usually be inclined to add to that amount by chasing down your preferential payee.

Second, there are many circumstances where forcing a preferential payee to repay the money would be difficult for the trustee. Your payee may have very little in assets or income reachable by the trustee, so it would likely take a very long time to collect it. Or the payee may have a valid defense. Especially if the amount at issue is relatively small (although above the above threshold), the trustee may decide such preferential payments are not worth chasing.

Third, there are other circumstances where the trustee simply could not collect from your payee at all. Your payee may have disappeared and can’t be located. Or your payee may be legally “judgment-proof”—have no assets or income reachable by the trustee. Helping the trustee learn the true facts along these lines could induce him or her make a sensible decision to abandon the preferential payment.

 

The Surprising Benefits: A “Preference” Payment to a Relative or Friend

April 9th, 2018 at 7:00 am

A preferential payment to a favored creditor—a relative or friend—can be a problem, but one which usually has a workable solution. 

 

Our last two blog posts have been about one of the more confusing parts of bankruptcy: the law of preferences. This law says that if a creditor takes or receives money from you within the 90 days before you file your bankruptcy case, the creditor may need to pay it back. A creditor would not pay that money to you but rather to your Chapter 7 bankruptcy trustee. The trustee would then pay out that money to creditors based on a priorities schedule in bankruptcy law.

Our last blog post was about how that priority schedule could result in most of that money going to a creditor you need and want to be paid. One example we used was a recent income tax debt. That can’t be discharged (written off) in bankruptcy. So preference law could result in the trustee getting some money back from a creditor you don’t care about to pay the tax debt so you don’t have to.

Preference Payments You DON’T Want Undone

But preference payments don’t just involve creditors you don’t care about. You may well not lose sleep over a trustee forcing a credit card company to return $1,000 it garnished from you on the eve of your bankruptcy filing. But what if you’d paid $1,000 on a personal loan to your brother or grandmother 6 months before filing bankruptcy? You’d promised to pay him or her back as soon as you got your tax refund, for example. So you did pay the $1,000. He or she really needed the money, and you felt huge emotional and ethical pressure to pay it. It was the right thing to do.

But now you hear from your bankruptcy lawyer that a Chapter 7 trustee could force your brother or grandmother to pay back that money. You feel that would be crazy, and wrong. Your brother or grandmother has long ago spent the $1,000 you paid on the loan. It would really be hard on them to now turn around and pay $1,000 to your trustee. In fact maybe one reason you paid off this debt was so that he or she would not be involved in your anticipated bankruptcy case. You may prefer that your relative not find out about you having to file bankruptcy. You can’t think of anything worse than he or she getting a demand from the trustee to pay the $1,000. This prospect may well turn you off about filing bankruptcy altogether.

The Solutions

However, this problem has a number of likely practical solutions. We’ll list them here and give brief explanations. Then next week we’ll expand on them to make sure they make sense.

1. Wait to File Until after the Preference Look-Back Period: With “insiders”—relatives and potentially anybody close to you–the look-back period is a full year before filing. It’s not just 90 days back, as it is with non-insiders. Regardless, especially if you are getting close to a year since your preferential payment, consider waiting long enough to avoid the problem altogether.

2. Persuade Trustee Not to Pursue the Preferential Payment: Your relative or other favored person that you paid may genuinely be unable to pay the $1,000 or whatever you paid. He or she may have no legally reachable income or assets. The trustee won’t want to waste money to pay his or her lawyer to fruitlessly pursue a preferential payment.  

3. Offer to Pay the Trustee a Reduced Amount Yourself: The trustee will usually not care where the preference money comes from—from the relative or other creditor who got your money, or anywhere else. So you could offer to pay that $1,000 or whatever that sum of money yourself. The trustee may even take monthly payments from you. Also, he or she may accept less than the full preference payment amount, subtracting what it would have cost in attorney fees and other costs for him or her to get it from your relative.

4. File a Chapter 13 Case to Prevent Pursuit of the Preferential Payment: Chapter 13 “adjustment of debts” often provides a very good solution. It works particularly if 1) you need to do a Chapter 13 anyway, 2) the preferential payment is large, and/or 3) none of the above solutions will work.

Next Time…

We’ll explain these four in our next blog post. The bottom line until then: a preferential payment to a relative and other favored creditor can be a scary problem, but it’s one that usually has a very sensible practical solution.

The Surprising Benefits: Use “Preference” Money to Pay a Favored Debt

April 2nd, 2018 at 7:00 am

When a creditor is forced to pay back recently received money through “preference” law, that money can go to pay a debt you want to be paid. 


Last week we introduced the law of preferences. This law says that if a creditor takes or receives money from you within the 90 days before you file your bankruptcy case, the creditor may need to pay it back. There are some complicated conditions that may apply, but in many situations the creditor does need to pay it back. See Section 547 of the Bankruptcy Code.

We ended last week by asking where this returned money goes. What good does it do you if that money just goes to your Chapter 7 trustee?  After all, this liquidating trustee’s job is to distribute that money among all your other creditors. So how does that help you?

Chapter 7 Trustee’s Collection of Bankruptcy Assets

It’s true that under Chapter 7 “straight bankruptcy” it’s your bankruptcy trustee who makes a creditor return a “preferential payment.” The Bankruptcy Code says “the trustee may avoid” a preference payment. It’s not you, the debtor, who has that role. Section 547(b). (“Avoid” means requiring the creditor to pay the recently received money back, but to the trustee.)

That returned money then goes into the pool of money the trustee uses to pay your creditors. In most consumer Chapter 7 cases that’s the only money available to the trustee. That’s because everything that most debtors own is protected through property exemptions. Exemptions are categories and maximum amounts of assets that you can keep in bankruptcy under state and/or federal law. So, when a trustee avoids, or undoes a creditor’s preferential payment, that money is all the trustee has to work with.

Whether the trustee only has the preference money or also liquidates an unprotected asset, what happens to the resulting money?

Chapter 7 Trustee’s Distribution of Bankruptcy Assets

Once the trustee has received the preference money (plus any other money from liquidating assets), he or she is required by law to then distribute that money in a very specific way. The law is laid out in the Bankruptcy Code’s Section 726, “Distribution of property of the [bankruptcy] estate.”

The distribution rules say that “priority” debts get paid in full before anything goes to any other debt.  Section 726(a)(1) says the money first goes to debts under Section 507, which are a listing of the priority debts.

When an “Avoided Preference” Directly Benefits You

Simply put, if you want or need to pay a debt that’s a “priority” debt, the trustee will pay it. The trustee will pay it out of the money it got from the creditor by “avoiding” the preference payment. The trustee will pay your favored priority debt before paying any other debt.

For example, an unpaid child support payment or recent income tax debt would be a priority debt. These debts could not be discharged—legally written off—in a bankruptcy case. So you’d have to pay them after your Chapter 7 case was completed. But the trustee would pay such a debt from the preference money. That would either eliminate or reduce what you’d have to pay yourself.

If your priority debt that you’d like to be paid is larger than the amount of money the trustee has from the preference, the trustee would only pay part of that priority debt. If the trustee has more than enough money, he or she would pay off the whole priority debt.

(The trustee also gets paid a fee out of the same money, so you need to take that fee into account. The fee is based on a sliding scale: a maximum of 25% on the first $5,000 distributed, 10% on the next $45,000, etc. See Section 326(a).)

Conclusion

Preference law can make a creditor give up money it took from you shortly before you filed your bankruptcy case. Then this same money can instead go to pay a priority debt which you very much want to get paid.

This is quite a nice benefit of bankruptcy. You can force one of your less important creditors in effect to pay your most important creditor!

Timing: Avoiding “Fraudulent Transfers”

October 4th, 2017 at 7:00 am

Giving a gift, or selling for less than true value, can cause problems when done before bankruptcy, but usually only if the amount is large. 

 

“Fraudulent Transfers” Are Uncommon

So-called “fraudulent transfers” do not come up in most consumer or small business bankruptcy cases. But they can sneak up on you. And if one does, it can be a real headache. So it’s important to know what it is, its crucial timing factors, and how to avoid it.

What’s a “Fraudulent Transfer”?

A fraudulent transfer is a reflection of human nature. If someone in financial trouble has an asset or money she wants to keep from her creditors she may be tempted to give it to someone so the creditors can’t reach it. Or she may be tempted to sell it for lots less than its worth.

The gift or sale may be to someone who would give it back later. Or the gift or sale may be to a friend or relative, keeping it within the debtor’s circle. The point is that the asset would no longer be available for her creditors to seize to pay the debts.

It’s human nature that if you have something valuable and are afraid of losing it, you hide it. You keep it from those who could take it. But that doesn’t mean this impulse is legal or moral. Because it’s an understandable impulse, there have been laws against it for at least 400 years in the English law we inherited.

The Results of a Fraudulent Transfer

So, a fraudulent transfer is a debtor’s giving away of an asset to avoiding paying creditors the value of that asset.

Under both federal and state fraudulent transfer laws if you give away something of value within the last two years, then your creditors could require the person to whom you gave that gift to surrender it to the creditors.

Legal proceedings to undo fraudulent transfers can happen both in state courts and in bankruptcy court. In a bankruptcy case, a bankruptcy trustee acts on behalf of the creditors to undo the transfer.

Actual and Constructive Fraudulent Transfers

There are two kinds of fraudulent transfers, based on either “actual fraud” or “constructive fraud.”

The one based on “actual fraud” happens when a debtor gives a gift or makes a transfer “with actual intent to hinder, delay, or defraud” a particular creditor, or his or her creditors in general. (See Section 548(a)(1)(A) of the Bankruptcy Code.) The debtor is acting with the direct intent to keep the asset or its value away from creditor(s).

Fraudulent transfers based on “constructive fraud” happen in consumer situations most often when a debtor gives a gift or makes a transfer receiving “less than a reasonably equivalent value in exchange,” AND the debtor “was insolvent on the date that such transfer was made.  . .  , or became insolvent as a result of such transfer.” (See Section 548(a)(1)(A) of the Bankruptcy Code.) With a constructive fraudulent transfer the debtor does NOT need to intend to defraud anybody. Yet the transfer can be undone if the right conditions are met.

Why Fraudulent Transfers Are Uncommon

There are three practical reasons why most people filing bankruptcy don’t have to worry about fraudulent transfers.

First, most people in financial trouble simply don’t give away their things before filing bankruptcy. They usually need what they have. Plus most of the time everything they do own is protected in bankruptcy through property “exemptions.” So there’s usually no reason to give away or sell anything.

Modest Gifts Are OK

Second, the bankruptcy system doesn’t care about relatively modest gifts. And most people considering bankruptcy don’t have the means to give anything but modest gifts.

By “modest” the bankruptcy system generally means a gift or gifts given over the course of two years to any particular person with a value of more than $600. The Bankruptcy Code does not refer to that threshold amount. But the pertinent official form that you sign “under penalty of perjury” does so.

The Statement of Financial Affairs for Individuals (effective 12/1/15) includes the following question (#13):

Within 2 years before you filed for bankruptcy, did you give any gifts with a total value of more than $600 per person?

The next question (#14) is very similar:                                            

Within 2 years before you filed for bankruptcy, did you give any gifts or contributions with a total value of more than $600 to any charity?

The Trustee Has to Consider Collection Costs

The third practical reason there usually isn’t a fraudulent transfer problem is what it costs the trustee to pursue one. The trustee has to pay attorney fees and other expenses to try to undo a gift or transfer. Or the trustee has to use his or her time or pay staff to do this. So the practical threshold value of the transferred asset is likely many hundreds of dollars. The trustee is not going to pay a lawyer or use his or her time when the likely benefits outweigh the costs.

This is important because there is a question in the Statement of Financial Affairs without a stated threshold dollar amount. This question (#18) asks:

Within 2 years before you filed for bankruptcy, did you sell, trade, or otherwise transfer any property to anyone, other than property transferred in the ordinary course of your business or financial affairs?

Notice the lack of a $600 minimum threshold found in the two questions referred to above. So, every applicable transfer must be listed here regardless of value.  But again, the bankruptcy trustee would likely not do anything about this unless the asset transferred was valuable enough to make the effort to undo the transfer worthwhile.

Caution

The trustee may be more inclined to try to undo a gift or transfer in one situation. If the trustee already has non-exempt (unprotected) assets to liquidate and distribute among the creditors, he or she may be more inclined to pursue a fraudulent transfer. That’s because then the trustee is not risking using his or her own money for the collection costs. The trustee knows there will likely be some money from liquidation of the non-exempt assets to pay those costs.

 

Timing: Avoiding Very Troublesome “Preference” Payments

October 2nd, 2017 at 7:00 am

Sometimes in bankruptcy doing the honestly right thing can cause you major problems. Making preference payments is a good example of this. 


The Understandable Inclination to Pay a Favored Creditor

If you’re having financial problems and considering bankruptcy, you might feel compelled to first take care of a special debt. You may owe a relative or friend who is in real need of the money. You may feel deep and legitimate pressure to pay part or all of it in spite of your own financial problems. You may figure, accurately or not, that you won’t be allowed to pay this person after filing bankruptcy. Or for various reasons you may not want to involve this person in your bankruptcy case. You may not want to have him or her know about it. So you figure the best way to do that is to pay off or settle the debt beforehand.  

But your intentions—good or otherwise—could significantly backfire, if you don’t know the law and don’t get good advice.

The Dangerous, but Avoidable, “Preference” Payment

“Preference” payments are among the most frustrating situations in bankruptcy. They seldom happen but are a major headache when they do.

Because of the trouble they can cause, trouble that is often easy to avoid, “preferences” are worth understanding.

The Law on “Preferences”

So what are “preferences” and why are they a problem?

Bankruptcy law say that if during the 365 day-period BEFORE filing a bankruptcy case you pay a creditor more than you are paying at that time to your other creditors, then AFTER your bankruptcy is filed that favored creditor could be forced to surrender to your bankruptcy trustee the money that you had paid to this creditor earlier. (See Section 547 of the U.S. Bankruptcy Code on “Preferences.”)

In other words if you pay a special creditor during the year before filing bankruptcy, that person (or business) could be required to return that money.

The money would usually be returned not to you but to your bankruptcy trustee, to be re-distributed among your creditors. So instead of having a satisfied favored creditor, you would likely have a very unhappy one. You had wanted to fulfill your moral obligation to the creditor. Instead he or she would get a legal demand by your trustee to cough up the money you’d paid. Your friend/relative would have to scrape up the money you paid to him or her months earlier—very likely spent by then—to pay to the trustee.

After this would happen you may even feel morally compelled to pay that person yourself a second time. You might want to make up for the money the trustee took away from him or her.

The Point of “Preference” Law

What could possibly be the point of this 1-year “preference” rule? It is meant to promote one of the basic principles of bankruptcy law—legally equal treatment of creditors. This principle applies mostly DURING your bankruptcy case. However, to a limited extent the law also looks 1 year backwards from the time you and your bankruptcy lawyer file your case.  

So people in financial trouble are discouraged from playing favorites among their creditors for a year before filing bankruptcy. This is supposed to make the situation more financially fair to all the creditors.

One Scenario

Here’s an example to help make sense of this odd concept.

Imagine that you’ve owed your sister $3,000 for money she lent you so that you could pay your rent. You haven’t had the money to pay any of it back. She now really needs the money. Plus you really don’t want her or the rest of your family to know you’re filing bankruptcy. You’ve stopped paying other creditors for a while so you’ve scraped together the money to pay off this debt. You intend to pay it off and then file bankruptcy right after because you’ve recently been sued by a creditor. You know your paycheck is getting garnished in a few weeks if you don’t stop that by filing bankruptcy.

But here’s what would happen if you paid off your sister and then filed bankruptcy (within a year after).

A month or two after filing bankruptcy your bankruptcy trustee would very likely demand that your sister pay $3,000 to the trustee. If she didn’t pay, the trustee would likely sue her to make her pay. Once she did pay, that $3,000 would be divided among your creditors according to a set of priority rules. Your sister would be out $3,000. You may then feel obligated to pay her that, again. She (and probably your whole family) would know about your bankruptcy filing. Everybody would be unhappy.

It’s Usually an Avoidable Problem

This “preferences” mess can be avoided simply by not paying your favored creditors anything during the year before filing. This includes both money and anything else of value.

And if you do pay anything to such clients, hold off on filing bankruptcy for a year after.

That’s easier said than done when you have creditors suing or creating other collections problems. Your lawyer could likely help keep these creditors at bay. More broadly he or she would put together your best game plan for dealing with all of this.

 

Introducing Fraudulent Transfers

April 24th, 2017 at 7:00 am

“Fraudulent transfers” have similarities to “preferences.” They are both worth understanding because they can cause unnecessary hassles.  


Asset Timing in Bankruptcy

Your Chapter 7 trustee usually mostly focuses attention on determining whether any of your assets are not “exempt.” You get to keep all exempt assets. If there are any assets that are not exempt, the trustee has the right to take them, liquidate them, and pay the proceeds to your creditors. However, in most consumer Chapter 7 cases all the assets are exempt so the trustee takes nothing. The debtor gets to keep everything.

In this process, the trustee is only interested in what you own at the moment you file your bankruptcy case. This timing gets quite precise. For example, what counts is the amount of actual cash you have on hand at that moment of bankruptcy filing. Same thing with the balance in your checking account(s) at that moment, and all your other assets. The amount of cash or money in your accounts the day before or the day after usually doesn’t matter. What matters is what you had at the moment of filing, with these and all your other assets.

Exceptions: “Preferences” and “Fraudulent Transfers”

This fixation on assets at the moment of filing has a few significant exceptions. We just spent our last six blog posts discussing “preferences.”

The law of preferences allows a bankruptcy trustee to get at something you owned BEFORE filing your Chapter 7 case. That “something you owned” is the money (or some other asset) with which you paid a debt during the 90-day (or sometimes the 1-year) period before filing bankruptcy. See Section 547 of the U.S. Bankruptcy Code. Under limited circumstances the trustee can recapture that payment, requiring the creditor to give that payment to the trustee. The trustee essentially undoes, or “avoids,” that payment. The trustee then uses the money turned over by that one creditor just like any other available debtor asset. The money is paid out to your creditors according to a detailed set of priority rules.

The law of fraudulent transfers is ANOTHER way for a trustee to get at something you owned before your bankruptcy filing. But a fraudulent transfer involves assets you sold or gave away, instead of payments you made to a creditor. The sale or transfer can be to anyone. The look-back time period is much longer—a full two years before filing, and sometimes can be longer. See Section 548 of the U.S. Bankruptcy Code. If the trustee succeeds in undoing, or “avoiding” the transfer, there’s essentially the same result as with any other available debtor asset. The trustee sells that asset and distributes the proceeds according to the same set of priority rules just mentioned above.

Voluntary/Involuntary, Good/Bad Intentions

In the last few blog posts we’ve shown how a preference payment to a creditor can be voluntary or involuntary. That is, you may make that payment freely, with full intention. Or the creditor may force it from you through a garnishment of your paycheck, or some other aggressive collection method. You may be intentionally favoring one creditor over your others, or may have no such intention. All these kinds of payments can qualify as a preference, if they meet some timing and other conditions. The trustee may have a right to “avoid” the payment and make the creditor give up the money.

A so-called fraudulent transfer is one that you do more or less voluntarily. You generally sell or give away your assets by choosing to do so, even if you might wish you didn’t have to. And in spite of the word “fraudulent,” a fraudulent transfer absolutely does not require bad intentions. Innocently selling or giving something away during the two years before filing bankruptcy may be a fraudulent transfer. All it takes is satisfying a number of timing and other conditions.

The Purpose of Fraudulent Transfer Law

This power in bankruptcy to undo a sale or gift is intended to keep the system fair and honest.

By “fair” we mostly mean fair between you and your creditors. Bankruptcy is mostly about debts and assets. In most consumer Chapter 7 cases, all or most of your debts get written off. And you get to keep all of your assets because they are protected, or exempt. But the system still gets to review your assets carefully to determine if you have anything that is not protected, and should be liquidated to pay your creditors. Part of that focus on assets is this power to look back at two years of asset transfers.

But why do “innocent” sales and gifts of assets get included? If the system is trying to discourage keeping assets away from your creditors, if that wasn’t your intention why might your sale or gift still be a fraudulent transfer? It’s because the law in this arena tries to be fair regardless of intention. We’ll show you what this means in the next couple blog posts.

Most Consumer Bankruptcy Cases Have No “Avoidable” Fraudulent Transfers

Let’s keep this all in perspective. There are a number of conditions for a sale or gift to meet to be considered a fraudulent transfer. Most consumer Chapter 7 cases do not involve a trustee trying to undo prior sales or gifts. That’s because in most cases the transfer doesn’t meet the necessary conditions. Or if the conditions are technically met the transfer is not worth for the trustee to “avoid” for practical reasons.

In the upcoming posts we will get into the conditions that create a fraudulent transfer. There are basically two kinds—intentional and unintentional. We’ll start next time with the kind involving the “actual intent to hinder, delay, or defraud” creditors. Section 548(a)(1)(A) of the Bankruptcy Code. 

 

Using “Preference” Law to Pay a Necessary Debt

April 21st, 2017 at 7:00 am

You can put a “preferential payment” to work for you if you owe a “priority” debt—back child or spousal support, or recent income taxes. 

 

Our last blog post was about how you can benefit from a “preference” in your bankruptcy case. A “preference” is a payment you made to a creditor (voluntarily or involuntarily) during the 90-day period before filing (or sometimes the 1-year period), which, under certain circumstances, your trustee can force the creditor to repay. The creditor doesn’t pay the preferential payment back to you but rather to your bankruptcy trustee. The trustee then distributes that money among your creditors. The way you benefit is when most of that money going to a debt that you need and want to be paid.

Last time our focus was on how a payment to a creditor qualifies to be a “preference.” That is, what it takes for the trustee to be able to force that creditor to give back the payment. Today is about how that money goes to where you want it to go.

“Priority” Debts

All debts are not created equal under the law. Not by a long shot. There is a short list of debts that are treated especially well in bankruptcy law. They are the “priority” debts. (See Section 507 of the U.S. Bankruptcy Code.)

There are ten types of “priority” debts, but only two that are common in consumer bankruptcy cases:

  • “domestic support obligations”—essentially unpaid child and spousal support
  • newer income tax debts—must meet certain conditions

A Chapter 7 bankruptcy trustee must pay all “priority” debts in full before paying anything on the ordinary debts. Also, the trustee pays a higher-priority “priority” debt in full before paying anything on another, lower, “priority” debt.

For example, assume you owe $2,500 in back child support, $3,000 in recent income taxes, and $100,000 in credit cards and medical debts. If the trustee would have $4,500 to distribute (after trustee fees), this is where it would go:

  • $2,500 back child support paid in full
  • the remaining $2,000 would go towards the income taxes, leaving $1,000 still owing
  • nothing would be available for the $100,000 in credit cards and medical debts

“Preference” Money Going to “Priority” Debt(s)

Simply put, any preference funds that your trustee receives will first go to your “priority” debt(s). Since back child/spousal support and recent income taxes are debts you would otherwise have to pay out on your own, you directly benefit from the trustee chasing down the preference money.

What could be better that having one of your creditors pay the debt owed to another creditor?! Even better, a creditor whose debt you are writing off, in effect pays all or part of a debt that you would have to pay yourself.

The Trustee’s Discretion

However, be aware that you have no real say about whether your bankruptcy trustee will pursue a preferential payment. The trustee has a lot of discretion about this. It’s not always easy to make a creditor disgorge a preferential payment. The trustee may decide that the costs of attempting to do so are too high compared to the anticipated benefit.

The Trustee’s Costs and Fees

Speaking of costs, the trustee usually gets to pay his or her costs of pursuing the preferential payment(s) out of the preference money recovered. That of course reduces the money available for the “priority” debt you want paid.

Also, as mentioned in passing above, the trustee gets a fee for his or her efforts (beyond the out-of-pocket costs). That fee is usually (unless the bankruptcy court disapproves):

  • 25% of the first $5,000 collected
  • 10% of the amount collected larger than $5,000 and up to $50,000
  • 5% of the amounts collected larger than $50,000 and up to $1,000,000

This fee also reduces the amount available to pay the “priority” debt(s).

Added to Funds from Non-Exempt Assets

Creditor-reimbursed preferential payments are just one potential source of money that a bankruptcy trustee distributes to “priority” and other debts. In some consumer bankruptcy cases the debtor has one or more assets that are not “exempt” (protected from the trustee). The proceeds of the trustee’s liquidation of such assets also get distributed to the creditors, “priority” and otherwise. Again, this is only after the trustee pays his or her own costs and fees.

Conclusion

If you have a “priority” debt, the trustee’s pursuit of a “preferential” payment may result in that “priority” debt being paid so that you don’t have to pay it. But there are hurdles to this working out to your benefit. Your trustee may or may not decide to pursue the “preference.” And if the trustee does pursue and get the preference money back, his or her costs and fees will reduce any amount going to your “priority” debt. On the other hand, the trustee may also be distributing the liquidation proceeds of any non-exempt assets.

In any event, it’s a good thing if as a result some or all of a support or tax obligation gets paid for you.

 

Using “Preference” Law to Your Advantage

April 19th, 2017 at 7:00 am

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:

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.”

For Example

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).

Avoiding the “Preference” Problem

April 17th, 2017 at 7:00 am

Prevent your trustee from giving you a big headache if you paid a debt to a friend or relative during the year before filing bankruptcy.  

 

In our 3 blog posts last week we explained “preferences” in bankruptcy. In particular, in our last one on Friday we showed how a “preference” claim by your trustee could cause you a significant problem. Doing something seemingly sensible before filing bankruptcy could cause trouble during your bankruptcy case. Today is about how to avoid that trouble.

Avoid the Risk of a “Preference”

A “preference” is a payment you make to one creditor in preference to your other creditors when you’re on the brink of filing bankruptcy. Specifically, it only involves payments made during the 90-day period before that filing. That period expands to the full year before filing if the creditor you pay is a friend, relative, or business associate.

Those 90-day and 1-year look-back periods are fixed, non-extendable. There is a straightforward way to take advantage of this. Just don’t pay anything you owe to a favored creditor during these periods of time. If you owe anything to a friend or relative, don’t pay them anything if there is any possibility that you’ll be filing bankruptcy in the following year. And don’t pay any other favored creditor during the 90-days before filing.

Otherwise you risk that your bankruptcy trustee will require the person you paid before filing to “return” that money to the trustee after you file bankruptcy.

The Realities of Life

There are situations that simply not paying that favored creditor is not that simple.

First, you may feel great pressure to make that payment. You owe some money to a relative who really needs you to pay some or all of it back. He or she trusted you and you feel duty-bound to show that you are trustworthy. Or your friend that you owe really needs the money now. Or you may want to pay in order to avoid including that debt in your bankruptcy case. You may not want to legally write off that debt. You may want to avoid having that friend or relative ever knowing about your anticipated bankruptcy filing. So if you are able to pay, it can be hard not to.

Second, you often don’t know whether and when you are going to file bankruptcy. Most people put it off because they understandably hope that they can avoid it. So being told to not pay a personally important debt in the one-year or 90-day periods before filing can be quite impractical advice.

Maybe sometimes, but not always. Just because you hope not to file bankruptcy, and don’t know when you will if you do, doesn’t mean you don’t know when you’re in financial trouble. If you are, be very cautious about paying a debt to a friend or relative. If you realize that doing so can cause you and the other person a major headache, you may find a better alternative.

Getting Advice

Your bankruptcy lawyer can hugely help in this. You can find out whether it is your best interest to be filing bankruptcy, now or in the near future. You can find out the best solution for dealing with your special creditor.

People understandable avoid seeing a bankruptcy lawyer until they feel that they have to file a bankruptcy case. But that is often not wise, because often the sooner you get advice the better. There are usually ways of meeting your needs that you didn’t realize. As the saying goes, knowledge is power. That’s true about your financial life in general, and in avoiding a possible “preference” as well.

Delay the Bankruptcy Filing

If you’ve already made a preferential payment, it may be worth waiting before filing bankruptcy. As mentioned above, those 90-day or 1-year look-back periods before filing your bankruptcy case are fixed. If you paid your grandmother $1,000 360 days ago when you got your tax refund, it’s usually easy enough to wait a week before filing so that payment is not within the year before filing. Then it’s not a “preference” and won’t be a problem.

If it isn’t already obvious, it’s crucial to be honest and thorough with your lawyer about any such payments you made. It’s easy to not think of debts to friends or relatives are real debts, them as real creditors. You may have paid in something other than money. Frankly, it may seem sensible to just pretend it didn’t happen.

But if you’re up-front with your lawyer there are usually solutions much better than not telling the truth. For example, most payments to creditors, including favored creditors, do NOT qualify as a preference. There are a number of elements that must be met for a payment to be legally a “preference.” See our blog post of a week ago for more about that. You may be worried about something not worth worrying about. There are many parts to your financial life and a good lawyer will help you find the best way to meet your goals.

You want to avoid creating a “preference.” Get legal advice so that you can do so and not worry about this.

 

The “Preference” Problem

April 14th, 2017 at 7:00 am

 Avoid the frustrating surprise of having one your friendly creditors be challenged by your bankruptcy trustee with a preference action. 

 

In the last two blog posts we’ve introduced “preferences.” Today we get into what we’re calling dangerous or bad preferences, ones you’d rather avoid.

Preference Law

A preference is a payment you make to a creditor before you file bankruptcy which the creditor must repay after you file bankruptcy. However, the money that you paid to the creditor does not come back to you. Instead it goes to your bankruptcy trustee, who then distributes it to your creditors under a strict priority system.

To be clear, most pre-bankruptcy payments you make to your creditors are not preferences. There are a number of timing and other requirements for a payment to be considered a preference. In fact, most consumer bankruptcy cases don’t have ANY preference issues.

But if a creditor in your bankruptcy case DOES get hit with an unexpected and unwanted preference demand, it can be awkward problem. That would especially be a shame because preferences are usually easily avoidable.

So today we show the kind of headaches a preference can cause. Then in our next blog post we’ll show you how to avoid them.

A “Bad” Preference

With most of your creditors you probably don’t care if your bankruptcy trustee wants them to pay back some money you’d paid them earlier. But if you have some special relationship with that debtor, you might deeply care. You probably made a point of paying that special creditor before you filed bankruptcy. So you’d understandably be unhappy if the creditor had to pay it to the trustee after you file.

We’re loosely calling a “bad” preference any in which you would not want the trustee to take back a payment you made to a creditor.

Stumbling into a Preference

Here’s how it usually happens.

You’re in financial distress. You may or may not be considering bankruptcy. But money is very tight so that you can’t pay all you debts as they come due. So you have to decide who you are going to pay at that point and who you are not.

So how do you prioritize? What if you owe a relative or friend some money? Maybe you don’t pay them because you tell them you’re having a tough time. You ask them to be patient.

But maybe you’re too embarrassed to do that. Or maybe you know that this person really needs the money. You may be thinking about filing bankruptcy. You’d rather the person not know about it if you do file, or not get hurt by it, or both. You may even think that it’s not legal to pay the person back after you file bankruptcy so you want to take care of it beforehand.

So some combination of pride and principle motivates you to pay him or her, even when it’s really tough to do. So you do.

Once You File Bankruptcy

Paying a debt to anyone who you want to favor during the one-year period before filing bankruptcy could result in that person being legally required to pay “back” to your bankruptcy trustee the amount you paid him or her. Look at our blog post of this last Monday about what conditions would make this happen. And then look at the very last blog post of Wednesday about why this happens less than you’d think.

Here’s what sometimes happens in real life.

There are a couple questions related to this in the formal bankruptcy documents that you file through your lawyer. These questions are about payments made to creditors before filing, including during the 365 day-period before filing the bankruptcy case.  But you make not consider the person you paid a “creditor.” Or you may honestly forget that you paid this person 10-11 months ago.

But then the trustee asks you about this a month or so later at the “meeting of creditors.” You realize that friend or relative was indeed a creditor. Or you now remember that you made that payment. And now the trustee wants to make that person pay the amount you paid, “back” to the trustee.

Messing Up Your Intentions and Expectations

Preference law can be extremely frustrating. Instead of you coming across as responsible and considerate to your favored creditor—the result can be the opposite.

You wanted to pay off that debt and fulfill a moral and legal obligation to that person. You may have not wanted the person involved in, or even aware of, your bankruptcy case. You wanted to be good to the person, avoid a headache for him or her, and for yourself.

But instead your favored creditor gets mixed up in your bankruptcy case after all. And this happens in a way potentially embarrassing to you and harmful to him or her. The person may have to give up the money you paid months earlier, and has most likely been long spent. And so the person has to scramble to come up with the money demanded by the trustee. 

Then after all this, your special creditor would again be out the money you paid. So at that point you may still feel that you have an obligation to make good on that debt. So you could end up paying that debt to him or her a second time, after your bankruptcy is over.

Clearly not a good result!

 Avoid the Risk of a “Preference”

The good news is that you can avoid this situation. Our next blog post on Monday will explain how.

 

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