Maybe a friend helped you out when money was tight, and you paid them back before filing bankruptcy. On the surface, that probably seemed responsible.
Bankruptcy law can treat that payment differently. In some cases, a trustee may try to recover money paid to one creditor shortly before the case was filed. These payments are called preferential transfers. The idea is to prevent one creditor from getting paid in full while others receive little or nothing.
Why Payments to Friends Can Get Extra Scrutiny in Bankruptcy
Repaying a friend isn’t automatically a problem. Timing is usually what brings the payment into focus. Say a friend lent you $5,000 and you repaid the full amount two months before filing Chapter 7. At the same time, you still owed money on credit cards and medical bills. The trustee may examine whether your friend received more than they would have received in the bankruptcy case.
If the payment meets the legal requirements for a preference, the trustee may try to recover it and bring the money back into the bankruptcy estate.
What Counts as a Preferential Payment
A preference isn’t just any payment you made before filing. Generally, you must have made the payment to a creditor for a debt you already owed. It also has to fall within the applicable lookback period and give that creditor more than it would have received in a Chapter 7 liquidation if the payment had never been made.
Repaying an old personal loan from a friend can fit that definition. A gift usually does not, because the recipient was not repaying a debt. Gifts can raise other bankruptcy questions, though, so you should still disclose them. There are also defenses to preference claims. The details of the transaction matter.
How Far Back a Bankruptcy Trustee Can Look
For most creditors, the preference period covers the 90 days before you file bankruptcy. Insiders are treated differently. A bankruptcy trustee can review payments to an insider for up to one year before filing.
A friend isn’t automatically an insider just because you are close. The law specifically identifies certain people, such as relatives, as insiders. Courts can also find that someone outside those categories qualifies based on the relationship and the way the transaction was handled.
In Minnesota, courts may look at whether the relationship was unusually close and whether the transaction was conducted at arm’s length.
When a Friend May Have to Return the Money
If the trustee successfully challenges the payment, your friend may have to give the money back to the bankruptcy estate.
That can be frustrating, especially if you repaid the loan because you felt personally obligated to make your friend whole. Bankruptcy law looks at the payment’s effect on all creditors, not just why you made it.
A payment made during the lookback period is not automatically recoverable. The amount, timing, relationship, and surrounding facts all affect the outcome.
What to Do Before Filing if You Repaid Someone You Know
Tell your bankruptcy attorney about the payment before you file. Give them the full picture. Explain when you borrowed the money, how much you repaid, when you made the payment, and how you know the person who received it. Don’t try to hide the transaction or move money around to fix it on your own.
The earlier your attorney knows, the easier it is to evaluate whether the payment may create a problem and what options are available.
Talk to a St. Cloud Bankruptcy Attorney About Recent Payments
If you recently repaid a friend, relative, or other creditor, review the payment before filing bankruptcy. At Kain + Henehan, we can look at the timing, amount, and circumstances and explain whether a trustee may be able to recover it. Contact Kain + Henehan by calling (612) 438-8006 or filling out the online form.