The Short Answer
A preference in bankruptcy is when you pay one creditor more than others shortly before filing — and the bankruptcy trustee has the power to reverse it. The trustee can demand that money back from the creditor and redistribute it equally among all your creditors. Secured debts like your mortgage or car loan are treated differently — keeping those current is not considered preferential. But paying off a credit card, a medical bill, or especially a family member or friend before filing can create serious problems for your case.
Preference in a bankruptcy means that you are showing favoritism to one creditor over the others. In other words, you treat one creditor better than another. For an example, let’s say that you received a bonus check of $1000 on top of your regular pay. You have a large number of creditors and you owe them all a considerable amount of money. However, you do have a charge card to your favorite department store and you choose to take your bonus check to pay off the $1000 balance on that account since you really like that card and want to be able to continue using it. Well, the court has a bit of a problem with that!
The court views this as “preferential treatment” and views it as you should have evenly spread out that $1000 by paying a little bit to each creditor instead of giving the entire $1000 to one specific creditor. Upon your bankruptcy filing, the bankruptcy Trustee will then contact that creditor (in this example is your favorite department store) and make them return the money to him so that he can divide it out equally among ALL of your creditors.
When you meet with your attorney prior to your bankruptcy filing, you need to discuss which creditors/debts you have been paying and the amounts that you have paid. You will also want to have an idea or timeframe as to when you will be filing your bankruptcy, so your attorney can advise you whether or not to pay any creditors and how much you should pay if you choose to pay them.
A normal credit card or medical bill can be deemed as preferential treatment but do not confuse this with your secured debts such as a home loan or car loan. If you are filing a Chapter 7 and plan on keeping your house and/or car, these loans MUST be current at the time you file your bankruptcy and kept current during your time in bankruptcy in order for you to keep them without any problems arising. Making payments to secured creditors above everyone else is not viewed as a preference.
Another important thing to keep in mind is that preferential payments to “insiders” – family members or friends – are also viewed as problematic. There can be consequences to paying family members or friends prior to your bankruptcy filing, so if you have done so or are considering do so and are also considering bankruptcy, you should talk to a bankruptcy attorney immediately. Depending on the circumstances, the bankruptcy Trustee may require the friend or family member you paid the money to to return that money to the Trustee so he can distribute it to your creditors. Therefore, it is very important to discuss this situation with your attorney prior to your bankruptcy filing.
If you are considering paying a debt prior to your bankruptcy filing, contact your bankruptcy attorney first to ensure that you are not going to cause problems later on in your case.
Key Takeaways
- Paying one unsecured creditor in full while ignoring others before filing bankruptcy can be clawed back by the trustee and redistributed to all creditors equally.
- Keeping your mortgage and car loan current before filing is not a preference — secured creditors must be paid to retain the collateral.
- Payments to insiders — family members or friends — are scrutinized even more closely and can be unwound by the trustee regardless of your intentions.
- The trustee contacts the creditor directly to recover preferential payments, meaning the person or business you paid may have to return the money.
- Before you pay any creditor while considering bankruptcy, talk to a bankruptcy attorney first to avoid creating complications in your case.
Attorney Insight
The mistake I see most often is someone paying back a loan to a parent or sibling right before filing — they feel a moral obligation to family, which I completely understand, but the trustee doesn't care about the relationship. That family member can be required to return every dollar to the trustee, who then distributes it to credit card companies and medical providers instead. Payments to insiders like family members are looked at over a full year before filing, compared to just 90 days for regular creditors — so even something you did many months ago can come back to bite your case. Always tell your attorney about any payments you've made to family or friends before you file.
