In general, if you are even remotely considering bankruptcy as a solution, you should consult with an attorney before making any financial decisions because the law can affect you and those you care about in surprising ways. If you owe money to family and/or friends, it is natural to want to take care of them by paying those debts before filing for bankruptcy. However, doing so may be doing a disservice to them and you.

When you pay on a debt you owe within the 90 days prior to filing for bankruptcy, that payment generally is considered a preference (one creditor is “preferred” and received more than it would have if the payment were spread out among all creditors). When the creditor you pay prior to bankruptcy is close to you, e.g. family, a business partner, and in some cases a friend, that payment is an “insider” preference and the look-back period is 1 year instead of 90 days.

Why does that matter? You must disclose all such payments, and the bankruptcy trustee can demand (by court action if necessary) that the insider creditor return the money they received.

For example, you repay $5,000 owed to your mother 6 months prior to filing for Chapter 7 bankruptcy. If you had held on to the money instead, you might have been able to protect it as “exempt” and then paid your mother after your case was filed. Now, there is no way to exempt the money paid and the trustee can demand that your mother turn over the money. In practice, and assuming you do not want your mother hassled when she did nothing wrong, your attorney might negotiate a resolution with the trustee to avoid having the trustee pursue your mother. But even in that scenario, you are paying an additional amount that could have been avoided.

Even if you already have recently paid an insider creditor, you should discuss that payment in a bankruptcy consultation as there may be strategies to minimize or eliminate the issue.

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