May I Repay Loans To My Family
Before I File For Bankruptcy
Richard Fonfrias, J.D.
Chicago's Financial Rescue & Bankruptcy Lawyer
Fonfrias Law Group, LLC
When times are tough, you would likely turn to friends and family members for loans. And, naturally, when you file for bankruptcy, you would prefer that they not be included in the group categorized as unsecured creditors. So, you'd like to repay those loans before you file. Here's how the bankruptcy court treats different types of creditors.
Insiders vs Non-insiders
In your bankruptcy filing, all of your creditors and debts are supposed to be listed. This includes secured and unsecured creditors. This allows the court to treat all creditors according to the bankruptcy laws. In this way, payments to your friends and family, your credit card company, your doctor, or your mortgage lender are dictated by the same set of laws and no one gets favored treatment.
In bankruptcy law, "insiders" are defined as people who are close to you, such as your parents, brothers and sisters, other relatives and close friends. The court looks closely at payments to these people because it knows you are likely to pay them before you file for bankruptcy. Payments to these people are called "preferential payments" and are not allowed under bankruptcy law. If you pay them within one year before you file bankruptcy, the court may void the payment and take that money from those insiders.
In addition, if you paid any creditor within 90 days of filing for bankruptcy, the court will look closely at that payment to see if it meets the test of a preferential payment. If the bankruptcy trustee thinks you paid a creditor that should not have been preferred over other creditors, the trustee may take back the money so it's available to pay all of your creditors.
Ongoing Payments Are Safe
Your ongoing monthly payments, such as utilities, rent, and mortgage payments are safe. The court isn't going to take back money that you pay to creditors on a monthly basis. The court is looking for payments you made that were not necessary.
In summary, the court scrutinizes payments made to non-insiders within 90 days of filing bankruptcy. It looks back at payments made to insiders for an entire year. The reason being that the court assumes you would rather pay off family members than an ordinary creditor, so the court looks further back thinking you would give family members preference over other creditors. The court isn't interested who loaned you the money. It is concerned only that all creditors are treated equally.
The bankruptcy court also looks as how you transfer property before you file bankruptcy. It doesn't want you transferring property to family members or friends in hopes of hiding it from the bankruptcy court. For example, you cannot give an expensive diamond and emerald ring to your cousin before you file bankruptcy to avoid having it sold to pay your debts.
You Can Protect Your Family's Interest
Loans from family and friends often lack any paperwork, such as a promissory note. In this case, the court will treat their loans as gifts. And, as such, the bankruptcy court will not include them in the process so they will not receive any payments.
If you want family and friends to have their loans protected, make sure they sign an official document that sets forth the parties to the loan, the loan amount, and the repayment terms. Otherwise, the court will not pay them and all of the money you pay will go to court-recognized creditors.
Even so, after your bankruptcy is over, you can still pay your family and friends the full amount you owe.
Chapter 7: If you file a liquidation bankruptcy, your bankruptcy will end in a few months and you can start repaying family and friends soon. You can also pay them from income you earn after you file bankruptcy.
Chapter 13: If you file a repayment plan bankruptcy, and if the loan is documented in writing, you can repay it through your payment plan. But you can pay it only in proportion to your other debts, and the plan can last up to 5 years, so it can take 5 years before you can commit any more toward the balance owed.
Tell Your Lawyer
When you're thinking about filing bankruptcy, make sure you tell your lawyer about loans from family members and friends, both those documents with and without promissory notes. Also, be sure to tell your lawyer about payments you made to anyone considered an insider so he can tell you whether any payments might be taken back by the court or whether the court will allow them.
If your lawyer thinks any payments you made might be considered preferential, he might advise you to wait before filing bankruptcy until the look-back period has passed. Also, you should discuss with the person who loaned you the money that the trustee might take back the money to pay other creditors.
Loans from family members and friends - and payments made to family members and friends - can get complicated. Make sure you discuss these subjects with a skilled, experienced bankruptcy lawyer because when you file for bankruptcy depends on these and other complex factors.
As always, you're welcome to call me at 312-969-0730.