Paying off a family loan before filing for bankruptcy is not recommended. The payment might be considered a preferential transfer. This can cause the court trustee to consider petitioning the court to retrieve your relative’s money (assets). This process is known as an avoidance suit.
If a trustee files an avoidance suit, it could delay the resolution of your bankruptcy. If the court determines you were attempting to hide assets, it might result in the denial of your bankruptcy.
Are Family Loans Common?
According to a 2019 Bankrate survey, 60 percent of respondents claimed they had lent money to a relative, expecting it back. So, yes, family loans are common.
Unfortunately, they often lead to poor resolution and can damage familial relationships. A whopping 37 percent of respondents reported losing money on daily loans. An additional 21 percent say the relationship bore a negative outcome.
How Does the Court Know If I Paid Off a Family Loan?
Although many people may attempt to pay the family back before filing bankruptcy, this action can hurt your filing and your family members. A bankruptcy trustee reviews your financial records for at least the 90 days preceding your bankruptcy. If the trustee notes a payment exceeding $600 to a family member, the court may consider that a preferential transfer.
The look-back period for repayment of debts is typically 90 days. However, if your creditor is a family member or “insider,” the look-back period is 12 months. To avoid this risk, you may have to wait at least 12 months after a family or insider loan repayment.
If you must file bankruptcy during the 12 months following a repayment, you must disclose this information to the court. The bankruptcy trustee might file an avoidance suit to recover the assets to put towards repaying your debts in the bankruptcy process.
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Do I Have to Mention My Family Debt?
Yes, you must disclose all debt. If the court discovers an undisclosed debt, it might be considered attempted bankruptcy fraud. You must disclose whether your loan was a handshake and cash deal or included an official promissory note. Most family or insider loans are considered general unsecured debt, placing it last on the list for settlement via the court.
You can discuss the loan with your family member and help them understand that they might be subject to an avoidance suit if you pay it back before filing. Under 11 USC § 547, the order of precedence is defined for repayment of secured debts in a bankruptcy. The policy prohibits one creditor from gaining funds from a debtor before others.
Being subject to an avoidance suit may cost your loved one more financial loss than waiting until your bankruptcy runs its entire course.
What Is an Insider Payment?
The term insiders in relation to bankruptcy are defined in 11 USC § 101(31). The legal listing is long but can be generalized as:
- Relatives, including parents, siblings, children, grandparents, great-grandparents, grandchildren, great-grandchildren, aunts, uncles, nieces, and nephews
- Persons related through marriage, adoption, and step-relationships
- General partners of the debtor
- Relatives of general partners
- Any partnership, including the debtor
- Any corporation where the debtor serves in an official capacity
The look-back period for persons or entities considered insiders is 12 months. Whether or not the loan contained a formal agreement, any payments made to an insider that is more than a regular, agreed-upon amount might be subject to clawback rules.
Understanding Preferential Transfers
A payment may be considered a preferential transfer if a debtor makes it within a 90-day window of a bankruptcy filing. If the transfer was to a person or entity classified as an insider, the time extends to one year preceding the bankruptcy. The debtor must be considered insolvent at the time of the payment, and in some cases the payment must be over and above any regularly scheduled payments.
How Can I Pay Off Family Debts Legally?
If you have a family loan, the best insurance to pay it off is formalizing it with a contract or promissory note. A court will likely place a handshake loan at the bottom of the repayment list or leave them out of the final settlement altogether. A formal agreement specifying the amount of the loan and repayment terms helps the court declare the family debt as an unsecured creditor.
When filing under Chapter 7, your debts will be forgiven, and you can resume repaying family members after the case closes. Under Chapter 13, your debts will be on a schedule of payment that might last 36 months to 60 months. If your family member is willing to wait, you could begin repayment after completing the Chapter 13 repayment plan schedule.
Consult With a Bankruptcy Attorney
At Farmer & Morris Law, PLLC, our bankruptcy attorney offers a free case evaluation for your convenience. We understand bankruptcy law and filing requirements and can guide you in rebuilding your financial life. If you have questions about bankruptcy, please contact our team for answers.