Dec 15, 2010

Chapter 7 Bankruptcy: Beware of Preferences and Pre-Bankruptcy Transfers

Many issues that arise in Chapter 7 bankruptcy relate to the means test. (For more on these, see my previous blog post Common Chapter 7 Bankruptcy Means Test Issues.) However, there are several issues that commonly arise in Chapter 7 bankruptcy that do not relate to the means test. These include preferences and pre-bankruptcy transfers.

Preferences

Preferences are payments made to some but not all creditors prior to your bankruptcy filing. Basically (with some exceptions), you can't make more than $600 total in payments to an arms-length creditor within a three-month period prior to your bankruptcy filing date -- and you can't make payments to creditors who are relatives or business associates within the year prior to you bankruptcy filing.

If you do engage in a preference, the bankruptcy trustee can demand that the recipient of the money turn it over to be distributed to your creditors. Where I have most-often encountered this rule is when a client has borrowed money from mom or dad or sis and then repaid them out of a tax refund. Believe me, it's not easy trying to explain that you can prefer mom over Citibank when it comes to repaying your creditors.

Pre-Bankruptcy Transfers

A related rule concerns pre-bankruptcy transfers. More than a few people who contemplate bankruptcy decide to give some of their valuable property to a friend or relative. Big mistake.

The basic rule is that while you are insolvent you can't make any transfers of real or personal property within the two year period prior to your bankruptcy filing unless you receive fair value in exchange and, if asked, are able to account for what you did with what you got. Most often, a violation of this rule occurs because of a lack of understanding about how bankruptcy works. Simply put, most property that people try to unload could have been kept under their state's exemption system - so there was no need to unload it in order to keep it. But, once you have done the deed it's often hard (but not impossible) to undo it.

To learn more about bankruptcy, check out Nolo's Bankruptcy Center.