If you pay back debts owed to family members or business partners within one year prior to filing Chapter 7 bankruptcy the trustee can go after the people you paid to return the money to the bankruptcy estate. You cannot pay your family and partners first and leave your general unsecured creditors, such as credit cards, to “pound sand” in your Chapter 7 bankruptcy. It’s called a “preference”, and the trustee can get the money back.
One of my ongoing clients is considering filing bankruptcy. When I asked him whether he had repaid any loans to family members recently he said that over the past year he had paid his father over $50,000 during the year. I told him that these repayments would be a big issue in a bankruptcy. I asked how he paid so much money to his father when he had also told me he wasn’t making much money and had no assets.
The man had a business that rebuilt and sold old automobiles. The business was a separate LLC. He and his father had an ongoing loan arrangement in which his father would advance funds to buy old cars and the parts to rebuild the cars. The client would fix the car, sell the restored car, and then repay his father with interest from the sale proceeds. This was a revolving and ongoing arrangement. Without his father’s loans and his repayment of the loans from sales the client could not conduct his business because he was not credit worthy at banks, especially in today’s lending environment. The $50,000 loan repayment amount is the sum of all money repaid from the sale of the cars.
Bankruptcy preference law has several exceptions, and this client’s arrangement falls within the exceptions. The client’s repayments to his father as part of his ongoing business financing is not the type of family loan repayment which is the subject of preference law. There would be a reversible preference if, on the other hand, the client had an ongoing obligation to repay his father $50,000 from a prior loan, and the client used non-exempt money to repay his father’s old loan while paying little or nothing to the non-family creditors.
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