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The Perils of Repaying Creditors in the Run-up to Bankruptcy

Medical bill and insurance form with calculator

Let’s say you’re considering bankruptcy, because you’ve got enormous credit card debt and medical bills. You’ve also borrowed a few thousand dollars from family and friends. You need to discharge the debt, or you’ll never turn your finances around. But while you’re okay with taking a hit to your credit score and living without credit cards in the near future, you’d feel guilty asking the court to discharge what you owe your family and friends. What can you do?

One thing you must not do is repay your family and friends and then declare bankruptcy. This would not only look bad; such transactions, called preference transfers, are reviewable by the bankruptcy court. In fact, the bankruptcy trustee has the power to unwind preference transfers, recovering the money from your friends and family and putting it back into your bankruptcy estate for distribution to your creditors.

The reason preference transfers are illegal is because the bankruptcy process treats similarly situated creditors equally. As far as the law is concerned, personal loans, credit card balances, and medical bills are all unsecured debt, and one creditor should not be favored over the other. The court has the power to review and unwind payments made ninety days prior to your bankruptcy filing for most of your creditors, but can look back as far as one year for insiders, those friends and family members with whom you have a special relationship.

The law also guards against fraud. Since friends and family often loan money without requiring a written contract, there is often no evidence of a loan being made. A bankruptcy filer could claim to be repaying a loan when he is really transferring funds to an insider to hold until the bankruptcy process is over.

There are various strategies for handling personal loans during bankruptcy, and an experienced bankruptcy attorney can help you select the most appropriate one for your circumstances. But in all cases, you want to avoid making a transaction that looks like a preference transfer.

If you’re considering personal bankruptcy, it’s important to realize that some actions you take with the best of intentions can hurt you. Call Miller Law Group, P.C. today at 434-202-5293 or contact us online to make an appointment for a FREE consultation.