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Archive for the ‘preferences’ tag

An Example of a “Preference”

December 10th, 2018 at 8:00 am

A “preference” makes more sense when you see an example. Here’s one. This also helps explain how to avoid creating one. 

 

Last week we explained why paying a creditor before filing bankruptcy could cause problems during bankruptcy. That’s especially true if the creditor you pay is one that you have personal reasons to favor. We explained the circumstances in which such a payment might possibly be considered a “preference,” or a “preferential payment.”  If so, your favored creditor could well be required to return the money you paid, except not to you but rather to your bankruptcy trustee, for distribution to your creditors in general.

We ended last week saying we’d next give you an example of a preferential payment made during the holidays, and practical ways to avoid it.

Our Holiday Example

Imagine that you owe your sister $3,000 for loaning you this money in 2016 to pay your mortgage (or rent). Nothing was put in writing, and you didn’t have to pay interest. But you and your sister agreed that you had to pay it back. Now she’s unexpectedly getting a divorce and she really needs the money. You’re planning on filing bankruptcy early in 2019. You’ve stopped paying most of your other creditors and are making extra money from a part-time job during the holidays. So you now have the $3,000 to pay her back.  

Here’s what would likely happen if you paid her now and then filed a bankruptcy case within a year of doing so.

A month or two after filing bankruptcy the bankruptcy trustee would very likely demand that your sister pay $3,000 to the trustee.

The $3,000 would likely be considered a preferential payment because it was:

  • made within 365 days before the bankruptcy filing
  • to an “insider,” which includes a “relative” (or within 90 days NOT to an “insider”)
  • while you were “insolvent”—essentially had more debts than assets
  • resulting in the sister getting more than she would in a Chapter 7 distribution of your assets  (usually just meaning more than getting nothing)

Assuming the payment meets these requirements of a preference, if your sister didn’t pay the bankruptcy trustee the demanded $3,000 the trustee would likely sue her to make her pay. Once the trustee got that $3,000, it would be divided among your creditors according to a set of “priority” rules. Your sister may receive nothing from this distribution, or likely only a small portion of the $3,000 you owed. Your effort at helping her would likely have seriously backfired.

Avoiding this Unhappy Result

You can avoid this preferential payment problem simply by not paying your sister anything during the year before filing bankruptcy. (This includes either money or anything else of value.)

Instead talk with your bankruptcy lawyer about how to best protect the $3,000 that you’ve scraped together. And then pay your sister after your bankruptcy case is filed. If you’re filing a Chapter 7 “straight bankruptcy” case, that may mean a delay of only a few weeks.  

If you’ve already made the payment to your sister discuss this as soon as possible with your lawyer. If may or may not be possible to undo this payment. If so, that may solve the problem. If not, it may make sense to wait for a year to pass from time of the payment to your filing.  (Or you may need to wait only 90 days if the person you paid does not qualify as an “insider.”)  Either way, in some circumstances it may not make sense to wait. Your lawyer will help you weigh your options.

Finally, what may seem like a preferential payment may in fact not be one. For example, if instead of paying your sister you paid your ex-spouse to catch up on a child support obligation, there’s a good change that would not be a preferential payment.

So again, talk with your lawyer right away if you think you may have made a preferential payment. Or preferably do so before you pay a creditor, in order to prevent doing what may not be in your best interest.

 

“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: Resolving the “Preference” Problem through Negotiation

April 23rd, 2018 at 7:00 am

Prevent your Chapter 7 trustee from requiring a relative or friend to return your pre-bankruptcy payment by paying the trustee yourself.  

 

Our blog post two weeks ago introduced an uncomfortable problem: preference payments to a friendly creditor. (Please read that blog post before reading this one.) Then last week we discussed two possible solutions to this problem. Today we discuss the first of two other solutions.

The First Two Solutions

One way to avoid this problem is simply to wait long enough so that enough time passes from the time of your payment to your favored creditor to the time you file your Chapter 7 bankruptcy case. That’s because a payment is considered preferential only if you paid it within a specific time period before your bankruptcy filing. That time period is only 90 days, or one year if the payment was to an “insider.” If you file your case after the pertinent time period has passed, the payment is no longer a preference. You’ve avoided the problem altogether.

The second way to solve the problem is for your bankruptcy lawyer to convince your Chapter 7 trustee not to pursue the preferential payment. That is, there are circumstances when it’s not cost-effective for the trustee to make your payee pay it back. Either the amount at issue is too small or the person you paid can’t be forced to disgorge the money.  

But what if neither of these would work? You couldn’t wait long enough to file your bankruptcy case. Or the trustee definitely intends to pursue your payee for the preferential payment. What other options do you have? Here’s a likely solution.

Offer to Pay the Trustee a Reduced Amount Yourself

A Chapter 7 trustee is required by law to gather whatever the law allows him or her to collect in your case. However, in most consumer Chapter 7 cases the trustee collects nothing—your case is called a “no asset” case. That doesn’t mean you have no assets. It means that all your assets are protected (“exempt”), AND the trustee has no right to anything else. On that second point, most of the time there are no preferential payments for the trustee to pursue.

But we’re assuming here that there IS a preferential payment that the trustee has decided to pursue. Let’s say you very much do not want the trustee to do that. You don’t want the trustee to require the person you paid earlier to now pay that money back to the trustee.

So as we said in the subtitle, you could instead offer to pay the trustee that same amount of money yourself.

Why Would You Want to Pay the Trustee Yourself?

Why in the world would you want to do that? You would if it was the best option for you.

Assume that you have very strong feelings against your prior payee being required to pay back the money you’d paid. Maybe you don’t want that person to even know about your bankruptcy filing. You certainly don’t want the bankruptcy trustee to tell him or her now to give the money you paid back to the trustee. You want to do anything to protect that person.

There’s also a good change that if the trustee did make the person pay the money, you’d have to pay the person again. You may well feel a moral obligation to make the person whole, after the trustee makes him or her to give up what you’d previously paid. If so, then you instead just paying the trustee would cost you the same while avoiding the trustee harassing your prior payee.  

Also, there’s a good chance paying the trustee yourself could save you money. There are costs and risks for the trustee in pursuing a preferential payment. If you pay the trustee yourself that would avoid those costs and risks. So the trustee may well be willing to accept less money—the amount it would have received from your payee minus the avoided costs.

Why Would the Trustee Take Your Money Instead of Your Payee’s?

The trustee doesn’t usually care where he or she gets the money from a preferential payment. Whether it comes from your payee paying the money back, or from you, money is money. The trustee can fulfill his or her responsibilities regardless where the money comes from. So, trustees generally are fine with you paying to avoid the trustee shaking down your payee.

However, that’s not always true. For example, most debtors don’t have the amount of money required payable in a lump sum. Often trustees are willing to let you pay the agreed amount in monthly payments. But the full amount has to be paid off relatively quickly. If the trustee has reason to think that money would come quicker from your payee, the trustee may just decide to get it from him or her instead.

Talk with your bankruptcy lawyer to find out the possibilities under your circumstances.

When Is Paying the Trustee Not a Good Idea?

The whole point of this effort is to protect the person you paid earlier. But there are various situations in which this goal does not apply.

You may not want or need to protect this person. You may not care that the trustee makes him or her pay back the money, for emotional or financial reasons. Frankly, you may have had a falling out with the person. Or, he or she may have plenty of money so that paying back the money may not hurt at all.

You may also not need to protect the person because the law protects him or her already.  He or she may have a valid legal defense to a trustee preference action. Bankruptcy preference law is quite complicated. Your bankruptcy lawyer will ask the appropriate questions to determine whether the person you paid may have a defense.

Your lawyer will also discuss whether the person may not need to pay the trustee for other practical reasons. For example, the amount at issue may simply be too small, or the person may be effectively “judgment-proof.” If so, you’d be wasting your money by paying the trustee yourself.

 

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!

Surprising Bankruptcy Benefits: Make Creditors Return Your Money

March 26th, 2018 at 7:00 am

Bankruptcy doesn’t just stop garnishments and other collections. Sometimes you can make a creditor return money it recently took from you.

 

Bankruptcy’s “automatic stay” is one of the most immediate and powerful benefits of bankruptcy. It immediately stops almost all creditor collection actions against you, your income, and your assets. See Section 362 of the U.S. Bankruptcy Code.  

But it does not go into effect until the moment you file your bankruptcy case. What if a creditor garnishes or otherwise gets your money right BEFORE you file bankruptcy?

Sometimes the creditor can be forced to give up such recently received money as well.

The Law of Preferences

This happens through the surprising and easily misunderstood law of “preferences.”

This law says that if a creditor takes money (or some other asset) from you within the 90 days before you file your bankruptcy case, the creditor may need to pay it back. It has to do so if keeping that money results in that creditor receiving a greater share of its debt than the rest of your creditors would get out of your bankruptcy case. See Section 547(b) of the Bankruptcy Code.

That second condition would often be met, especially in a consumer Chapter 7 “straight bankruptcy case.” So, most money grabbed by an unsecured creditor within 90 days before your bankruptcy filing can be “avoided.” The creditor can be forced to return it.

For example, let’s say an aggressive unsecured medical debt collector garnishes your checking account. You’ve just deposited your paycheck and the creditor grabs $2,000. You owed $5,000 so this creditor just got paid 40% of its debt. Then you file your Chapter 7 case a day after the creditor garnished your money. Assume you owe a total of $75,000 in general unsecured debts. If in that Chapter 7 case—as in most—all your assets were “exempt” (protected), those debts would receive nothing. So, the garnished $2,000 would be a preferential payment that could be reversed. That’s because it happened within 90 days before filing and resulted in the creditor getting 40% instead of nothing.

(There are a number of other conditions and exceptions to a preference, but they often don’t apply to consumer cases. However, preference law can sometimes get quite complicated. You need to talk with your bankruptcy lawyer to find out if you really have an avoidable “preferential payment.”)

The Principles behind Preference Law

Preference law serves two principles important to bankruptcy.

First, bankruptcy law tries to discourage overaggressive creditors. The risk that a creditor would have to return money grabbed just before the debtor files bankruptcy is supposed to be a disincentive for such a money grab.

Second, a lot of bankruptcy law focuses on maintaining fairness among creditors. Similarly situated creditors should be treated the same. No playing favorites unless there is a legally appropriate reason to do so.  (On such reason would be if the debt is secured by collateral).

This fairness means that legally similar creditors need to be treated the same not just during your bankruptcy case but also shortly before the filing of your case. The period of fairness extends a bit before the bankruptcy filing so that overly aggressive creditors aren’t favored. Any available money or assets are spread among all the creditors more evenly and thus more fairly.

A Preference Benefitting You

It’s all well and good to punish a creditor for grabbing money from you shortly before you file bankruptcy. But what good does it do you if that money just goes to your Chapter 7 trustee?  The trustee would just distribute that money among your other creditors, right?

Generally, yes. But in many circumstances this preference money helps you very directly. Next time we’ll show you how.

 

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.

 

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