One of the big goals of bankruptcy is to ensure that all creditors who are similarly situated are treated equally and fairly. There are two ways in which debtors will sometimes violate this goal.
First, they won’t list all of their creditors in their bankruptcy papers. This is a serious infraction because the debtor, or debtor’s representative in a business bankruptcy, testifies under penalty of perjury that all creditors have been included in the papers. Since a debtor is required to list all creditors, not listing them will set the stage for prosecution for perjury. The good news: free room and board. The bad news: it’s in a federal penitentiary. So list all of your creditors in your bankruptcy papers.
Second, some debtors make preferential transfers or payments to some creditors in anticipation of bankruptcy,
perhaps hoping to curry favor with those creditors.
I. “Avoiding” Preferential Transfers
Preferential transfers are “avoidable” – undone and rendered null and void – by the Chapter 7 or Chapter 13 Trustee under 11 U.S.C. § 547(b) and (d). When a trustee avoids a preferential transfer the trustee seizes the asset from the transferee. The trustee will NOT give the asset back to the debtor. Instead, the trustee will liquidate the asset and distribute the proceeds to the creditors on a pro rata basis according to certain priority rules found in 11 U.S.C. § 507.
II. Timing Of The Transfer
How far back can the trustee go? The answer depends on the identity of the creditor who received the preference. If the creditor is an insider (see 11 U.S.C. § 101(31) for the complete definition; the gist is: a close business associate or family member) the trustee can go back a year from the date of the filing of the bankruptcy petition. If the creditor is an ordinary creditor (i.e., one who is not an insider) the trustee can only go back ninety days.
The clock starts to tick on the date the transfer was perfected. If the asset transferred was real estate, the clock starts to tick when a subsequent bona fide purchaser cannot acquire a superior interest in the property – usually when the transfer is duly recorded with the county. If the transfer was the payment of funds, then the transfer is perfected on the date the bank honors the check rather than when the transferee received the check. Barnhill v. Johnson, 503 U.S. 393 (1992).
Not all transfers made shortly before filing for bankruptcy are preferential transfers. The complete list of exceptions can be found in 11 U.S.C. § 547(b). The most important exception for most filers is a transfer made in the “in the ordinary course of business or financial affairs of the debtor.” This means that if you make your regular monthly car or mortgage payments, the trustee assigned to your case will not avoid that transfer. However, if you decide to get ahead by making a multi-month payment all at once, the trustee will avoid the portion in excess of your normal monthly payment.
IV. Cautionary Note
If you are thinking of filing for bankruptcy protection, do not make large payments to creditors – especially creditors who are family members. If you do, your trustee will seize the payments and you’ll be in worse shape with those family members than if you hadn’t made the payments.