Even though it is natural for someone that is filing for bankruptcy to want to favor one creditor over another, the unfortunate fact in bankruptcy is that all similar class creditors must be treated fair and equal. It does not matter if this favored creditor is a family member, business partner, or simply your favorite credit card the fact remains that if all of the above are unsecured creditors, they must be treated the same.
When filing for bankruptcy you must report those to whom you have paid a substantial sum of money prior to filing. In most cases a substantial sum is considered to be anything above $600. This is amount is not a fixed amount and it is up to the trustee to decide which amount is worthwhile to pursue. There are trustees who will require that a creditor returns a $300 payment. Each debtor has to list payments within 90 days prior to filing the bankruptcy petition if the aggregated value of all transfers is $600 or more. If a debtor is married and files a chapter 13, debtor has to include also payments made by his/ her spouse to creditors of more than $600. All payments to friends or family members made within the last year before filing have to be listed on the petition. These payments, if paid in a disproportionate amount as to the other similarly classified creditors and to the amount you owe each, could be viewed as favoring one creditor over another.
An example of this would be if you owe the following to unsecured creditors:
1. Creditor 1 – $3,000
2. Creditor 2 – $6,000
3. Creditor 3 – $9,000
Imagine if you had $2,400 cash on-hand that you wanted to pay toward your unsecured debt. In this instance you would have to split the $2,400 and pay it to each creditor in a proportionate amount to the total amount owed.
The allocated payment amount would be calculated by first determining what percentage of the total debt you have to pay toward the unsecured creditors. In this case you have $2,400 in cash on hand to pay toward a total of $15,000 in debt to those creditors. Therefore you have 13.33 percent of your total debt in cash and would be required to pay 13.33 percent toward each creditor. It would calculate out to the following:
1. Creditor 1 – 13.33 percent of $3,000 equals a payment of $400.
2. Creditor 2 – 13.33 percent of $6,000 equals a payment of $800.
3. Creditor 3 – 13.33 percent of $9,000 equals a payment of $1,200.
As a result of this calculation and fair treatment toward all creditors $400 would go to creditor 1, $800 to creditor 2, and $1,200 to creditor 3.
Unfortunately what is all too common is that a person who has filed for bankruptcy pays the entire $2,400 to their favored creditor, typically a friend or family member and at other times a favorite merchant. This could be considered as a preferential payment (see section 547(a)(b) Bankruptcy Code). What then happens is that the bankruptcy trustee will force that creditor to return the entire amount of the payment to the trustee and then the trustee will redistribute the funds in what the trustee determines is a fair and non-preferential manner.
This can become a particularly difficult situation if the creditor is a friend or family member. In some cases debtors do not want their friends and family members to know that they filed bankruptcy. That might have been the reason they paid them of in the first place.
This situation increases in its impact upon your favored creditor if they have spent the payment and not have it within their means to return the favored payment to the court. The friend or family member might not have known about the bankruptcy and was happy about getting repaid an old debt. The creditor might have spent the money already.
But even if the creditor spent the money, the trustee might insist on turnover of the payment and eventually might sue the friend or relative. This might cause problems between debtor and creditor. In addition, after the trustee received the money and voided the transfer, debtor will not be allowed to apply any exemptions towards the money. This is true even if the whole amount that was transferred could have been exempted if the money would not have been transferred.
The time period for determining if a payment has been made that favors a creditor, is typically 12 months for payments to friends and family and 90 days for payments to other creditors. Understanding these rules is critically important and aids in the smooth and quick resolution and discharge of a bankruptcy case. It can also save your friends and family a lot of trouble when you avoid showing them favor in paying off debts.