Learning About Preferential Payments Before Bankruptcy

Some chapter 7 filers may find out that their actions several months before they file bankruptcy can affect their ability to obtain debt relief. To learn more about preferential payments, read on.

Chapter 7 and Liquidation Rules

Many filers overlook the potential for their assets to be used to pay creditors. The idea of bankruptcy is to allow filers to be free from some or all of their debt but, while doing so, the courts try to pay the creditors as much as possible. That is why the bankruptcy trustee has the power to seize certain assets and use the funds garnered from the sale to pay certain creditors. Most filers don't have anything to worry about since their assets are protected by exemptions. Those with very high incomes are more likely to exceed their exemption allowances and lose property to the trustee. The bankruptcy trustee, however, has the power to look at previous assets as well as current assets.

Priority Creditors

It might be helpful to picture your creditors as a list. The bankruptcy code assigns each creditor a priority. In most cases, for example, taxes are a very high priority and credit cards a low priority. Any assets seized, therefore, go to pay the highest priority debts. It gets more complicated, though. The trustee may look at your previous creditor transactions and "undo" them if they don't meet the standard. For instance, if you paid off a personal loan a few months before you filed bankruptcy, the trustee can try to take that money back from your friend or loved one. The problem is that you treated the personal loan as a preferential payment and your friend is not considered a priority creditor. The same thing can apply if you paid more than was necessary to anyone you owed money to—from credit cards to medical debts.

What Else to Know About Preferential Payments

  • Be sure to let your bankruptcy lawyer know about any large transactions you made in the year prior. That means all payments as well as any property sold or given away.
  • Small sums of money paid to creditors (less than a hundred dollars or so) may not cause problems unless there are dozens of such incidences.
  • It should be emphasized that this is not considered fraud. Many people pay off creditors before they even consider filing for bankruptcy. However, the trustee can still undo the transaction.

For more information on preferential payments, speak with your bankruptcy attorney.