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Archive for the ‘preference payment’ tag

“Preferences” Around the Holidays

December 3rd, 2018 at 8:00 am

Do you feel like you should pay on or pay off a certain debt now, even though you’re behind on all your debts?  It may be dangerous to do so. 

 

Last week we explained how giving a significant gift before bankruptcy could cause problems during bankruptcy. This also applies to selling something for much less than it is worth. Such a gift or sale might possibly be considered a “fraudulent transfer.”

A similar problem could arise from paying a creditor before you file bankruptcy. That’s especially true if it’s somebody you want to favor or maybe don’t even see as a regular creditor. This payment might possibly be considered a “preference,” or a “preferential payment.”  This is today’s topic.

Your Desire and Ability to Pay a Special Creditor

Especially around this time of year you may be extra motivated to pay on or pay off a special debt. A relative, or a friend, may really need of the money. He or she may be pressuring you to pay.

You might be thinking about filing bankruptcy and you don’t want it to affect this person. So you pay him or her off thinking that would help. Or you do so because you don’t want the person to know about your bankruptcy, for whatever personal reason.  

Besides wanting to, you may be able to pay on a special debt this time of year more than usual. For many people because of the expenses of the holidays money is especially tight. But, as mentioned a couple weeks ago:

The month of December is the month that people receive more income than any other month of the year. [F]or at least the past 9 years U.S. personal income was the highest in December… .

You may be getting a bonus from work or more income from working extra hours or part-time job during the holidays. So you might be able to pay a special debt now more than at any recent time.

So you may have the desire and ability to pay a debt now, before filing bankruptcy. But it may not be a smart thing to do.

What Makes a “Preference”?

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’d paid to this creditor earlier. See Section 547(b) and (c) of the U.S. Bankruptcy Code. 

This one-year look-back period is shortened to only 90 days for creditors that are not “insiders.” The Bankruptcy Code defines “insiders” basically as relatives and business associates, but the definition is open-ended. See Section 101(31). So it could include friends and just about anybody that you have a personal reason to favor. Your bankruptcy lawyer will advise you whether a potential preferential payment was to an insider or not.

Your favored creditor could be required to return the money (or other form of payment) that you’d paid. The money would usually not be given to you but to your bankruptcy trustee. The trustee would then distribute it among your creditors.

The result: instead of satisfying your favored creditor as you’d intended, you could have an unhappy one. This is not.

What’s the Point of All This?

Preference law is related to one of the most basic principles of bankruptcy—equal treatment of legally similar creditors. People or businesses which are financially hurting must be discouraged from favoring any of their creditors before filing bankruptcy. Otherwise they would—the theory goes—pay all of their last money or other resources to their favored creditors, leaving nothing for the rest of the creditors. Under preference law, if they do so within the 365-day/90-day look-back periods, those payments made to the favored creditor could be taken back from that creditor. This disincentive is supposed to make the situation fairer to all the creditors.

“Preferences” Can Be Frustrating, But They’re Avoidable

“Preferences” are relatively rare problems in consumer bankruptcy cases, partly because they are relatively easy to avoid. Next week we’ll give you a scenario showing a potentially preferential payment made during the holidays, and practical ways to avoid it.

 

The Surprising Benefits: Resolving the “Preference” Problem through Chapter 13

April 30th, 2018 at 7:00 am

Avoid the risks or persuading or negotiating with the Chapter 7 trustee by solving your preference problem through Chapter 13. 

 

Our last several blog posts have been about the problem of preference payments:

  • 3 weeks ago we introduced the problem resulting from paying a favored creditor before you file bankruptcy
  • 2 weeks ago we discussed avoiding the problem by delaying filing your case or persuading the trustee to do nothing
  • Last week was about negotiating with the trustee to pay off the preference money yourself

Today we get into how to solve this problem by filing a Chapter 13 “adjustment of debts” case instead of a Chapter 7 “straight bankruptcy” one.

When Filing a Chapter 13 Case May Be Worthwhile

A Chapter 13 case is very, very different from a Chapter 7 one. For starters, instead of taking about 4 months a Chapter 13 case almost always takes 3 to 5 YEARS.  Using it to resolve a preference is almost never a good enough reason to file a Chapter 13 case.

But Chapter 13 CAN be better than Chapter 7 in many situations. It can accomplish a lot that Chapter 7 can’t. So if you already have a good reason or two to consider a Chapter 13 case, using it to solve a preference problem as well may push you in that direction.

Let’s say you have an expensive vehicle loan that you’re a month behind on. Chapter 13 would allow you to cramdown that loan. That would reduce your monthly payments and the total you would pay. Plus you wouldn’t have to catch up on the missed payment. Yet you’re on the fence as you wonder if the disadvantages of Chapter 13 outweigh these savings. So if you have a preference problem that Chapter 13 would deal with, that could push you into deciding on Chapter 13.

When You Really Need to Use Chapter 13

The Chapter 7 solutions don’t always work:

  • You often don’t have the luxury of delaying your bankruptcy filing enough so that more than 90 days has passed after the preferential payment. (Or a full year has passed, if the payment was to an “insider” creditor)
  • The trustee may pursue your previously paid creditor in spite of your bankruptcy lawyer’s efforts to dissuade the trustee.
  • You may not have the ability to pay off the trustee yourself. Or you may owe too much to pay it off fast enough to satisfy the trustee.

So you’re looking to file bankruptcy and your lawyer advises you that none of these three are going to work. Then, if you want to avoid having a Chapter 7 trustee chasing your prior-paid creditor, consider the Chapter 13 solution.

How Does Chapter 13 Fix a Preference Problem?

Chapter 13 solves the preference problem by enabling you to pay the trustee within your payment plan. You pay enough extra money into your Chapter 13 plan to pay what you would have paid a Chapter 7 trustee. But you have significant advantages in doing it this way.

But first an example to show how this works. Assume you paid off a debt of $2,500 to your sister 60 days before filing bankruptcy. You’d gotten a tax refund and she desperately needed the money. You’d put her off for years and then had promised to pay her from the refund. Now you’re about to have your home foreclosed on so you can’t wait to file bankruptcy. If you filed a Chapter 7 case the bankruptcy trustee would force your sister to return the $2,500. She’d get sued if she didn’t. You absolutely don’t want that to happen. So you file a Chapter 13 case—which you be doing anyway to save your home. Your lawyer calculates your Chapter 13 payment plan to pay an extra $2,500 beyond what you would otherwise need to pay. You pay that extra amount over the course of your 3-to-5-year case. This may increase your monthly payment somewhat, or it may extend the length of your case. But your sister would not have to pay back anything. The trustee would have no need to even contact her.

Advantages of Using Chapter 13

1. When you file a Chapter 7 case hoping to persuade the trustee not to pursue your prior payee, you may not know if that’ll work. Or if you hope to negotiate payments to the trustee, you don’t know if that will work. The trustee may want to try to get the money out of your payee after all. Or your trustee may reject your offer in order to get the money faster from your payee. Using Chapter 13 takes away these risks. The system allows you to use your Chapter 13 plan to pay what’s needed.

2. Chapter 13 gives you much more time to pay what you need to pay. A Chapter 7 trustee’s job is liquidation. He or she is under pressure to wrap up your case quickly, and so will pressure you to pay quickly. Ask your lawyer but generally a Chapter 7 trustee won’t give you more than a year to pay up. And he or she may simply require you to pay it all in a lump sum. In contrast, under Chapter 13 you have 3 to 5 years to pay.

3. You have more control over where the money goes, and when. Chapter 13 is often used to pay creditors that you want to or need to pay. For example, if you owe a recent income tax debt or back child support, it’s much better to have those debts paid through a court-ordered Chapter 13 payment plan.

4. You have more control over when debts are paid. If you have a debt or two that needs to be paid quickly, that can often be paid first. For example, if you need to catch up on a car payment (because it doesn’t qualify for cramdown), your plan may front-load money there. The extra money you are paying because of the preference can be put to better use early in your case.

 

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 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.

 

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210-342-3400

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