Q:  My friend loaned me money to pay my rent, and now I want to pay her back. Am I allowed to do so prior to filing for bankruptcy?

A: You may, but you should not. Any payments made to insiders, which are friends or family members, in repayment of a loan within the one year period prior to filing for bankruptcy are considered preference payments. The payment is considered preferential because the payment preferred a friend or family member over other creditors. Since all creditors are required to share a distribution in bankruptcy, all creditors should have received a portion of the money paid to friends or family members.

The Bankruptcy Code allows the trustee to recover any preference payments made within the one year period prior to the bankruptcy filing.  The trustee is authorized to do so in order to ensure that all your creditors receive equal shares of a distribution. Any payments made over one year prior to the bankruptcy filing are not collectible by the trustee.  The trustee also cannot demand the return of sums less than $600.00, but care should be exercised nonetheless.

All payments to friends or family members in repayment of a loan within the one year period prior to filing for bankruptcy must be disclosed on the bankruptcy petition. Your assigned trustee thus will know about these transactions. Furthermore, the trustee routinely examines your bank statements, looking for large deposits and withdrawals. If large deposits and/or withdrawals are present, you should expect the trustee to ask for a detailed explanation of each transaction at the §341 Meeting of Creditors.

The assigned trustee will request contact information for each preference recipient. The trustee will send a formal written demand to each recipient demanding the return of any monies paid within the one year period to filing for bankruptcy. If the recipient refuses to turn over the funds, the trustee may elect not to pursue the matter on the grounds that the cost of recovery would exceed the return. However, the trustee may instead sue the recipient in federal bankruptcy court. The court may order the turn over of the preference and award litigation costs including attorney fees against the recipient if the trustee is successful.

Often times, the trustee will afford the debtor an opportunity to pay the bankruptcy estate the value of the preference. Trustees routinely allow the repayment of a preference over six months or one year. For the debtor who wants to avoid letting friends and family members learn about the bankruptcy filing, this repayment option can be a blessing.

You may voluntarily repay any creditor after the bankruptcy case is filed. Thus, the best way to repay a loan to friends or family members if you expect to file for bankruptcy is to simply wait until after the bankruptcy filing. Payments to friends or family members after the case is filed do not have to be disclosed.

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