When you are struggling with debt, your natural instinct is to take care of the people who have taken care of you. If a parent, sibling, or close friend loaned you money to help keep you afloat, it is completely understandable that you’d want to pay them back as soon as you have the cash—especially before you file for bankruptcy.
However, in the world of bankruptcy law, this noble gesture can lead to a legal headache for both you and your loved ones. At Caldwell Law, we often advise clients to hold off on these payments for a very specific reason: the one-year “insider” look-back period.
The Problem: “Preferential Transfers” (11 U.S.C. §547)
The bankruptcy system is built on the principle of fairness. The court wants to ensure that all of your creditors—whether they are a giant credit card company or your Aunt Sally—are treated equally.
If you pay back a family member but don’t pay your other creditors, the law views this as a preferential transfer. You are “preferring” one creditor over another. While this feels like the right thing to do personally, the law sees it as unfairly depleting the assets that should have been shared among everyone you owe.
The One-Year Look-Back Rule
For most standard creditors (like banks or medical providers), the court looks back 90 days before your filing date to see if you made any large payments. However, for “insiders”—a legal term that includes relatives, close friends, and business partners—that window expands to one full year.
If you made a payment to a family member within 12 months of filing for bankruptcy, the court will likely flag it.
What Happens if You Make a Payment?
If the bankruptcy trustee discovers you paid back a family member within that one-year window, they have the power to “claw back” that money. Here is how that typically plays out:
- The Trustee Sues Your Relative: The trustee can actually file a lawsuit against your family member to force them to give the money back to the bankruptcy estate.
- The Money is Redistributed: Once the trustee recovers the funds, they distribute them “pro-rata” (proportionally) among all your other creditors.
- Strained Relationships: Nothing ruins a family dinner like your sibling getting a legal summons because you tried to do them a favor by paying back a loan.
Can I Still Pay Them Back Later?
The good news is that bankruptcy does not prevent you from being a person of integrity. Once your bankruptcy case is finished and your debts are discharged, you are legally allowed to voluntarily pay back anyone you want.
The key difference is the timing. If you pay them before you file, the trustee can take it. If you pay them after your case is closed, it is your money to do with as you wish, and the court has no claim to it.
How to Protect Your Family
If you have already made payments to a family member, don’t panic—but do speak with Caldwell Law immediately. We can help you determine the best path forward, which might include:
- Delaying your filing until the one-year window has passed.
- Disclosing the payment and working with the trustee to resolve the issue without involving your family member directly.
- Choosing a different Chapter of bankruptcy (like Chapter 13) where you might be able to “buy back” the preference so the trustee doesn’t go after your relative.
Pre-Bankruptcy Financial Checklist: Dos and Don’ts
Navigating the months leading up to a bankruptcy filing can feel like walking through a minefield. To protect your family, your assets, and your legal standing, keep this checklist in mind as you prepare.
The “Don’ts”
- DON’T pay back family or friends: As discussed, any payment over a certain threshold made to “insiders” within one year of filing can be clawed back by the trustee.
- DON’T transfer titles: Avoid moving a car title, deed, or business interest out of your name and into someone else’s. This can be flagged as a “fraudulent transfer,” even if you didn’t mean any harm.
- DON’T take out new debt: Using credit cards or taking out a personal loan shortly before filing can be seen as “bad faith,” and those specific debts may not be discharged.
- DON’T hide assets: Whether it’s cash under the mattress or a hidden savings account, the bankruptcy court requires full transparency. Dishonesty can lead to your case being dismissed or even criminal charges.
- DON’T raid your retirement accounts: Most 401(k)s and IRAs are protected in bankruptcy. If you withdraw that money to pay off bills now, you are losing a protected asset to pay off debt that would have likely been wiped out anyway.
The “Dos”
- DO keep meticulous records: Save your bank statements, pay stubs, and tax returns for the last two years. The more organized you are, the smoother your filing will go.
- DO continue paying on secured “keep” items: If you intend to keep your home or your car through bankruptcy, continue making those regular monthly payments.
- DO use your income for “necessities”: It is perfectly legal to spend your earnings on rent, groceries, utilities, insurance, and necessary medical care.
- DO be honest with your attorney: Your lawyer is there to protect you, but they can only fix the problems they know about. Disclose every debt and every major payment you’ve made recently.
- DO seek professional advice early: The sooner you speak with a bankruptcy expert, the easier it is to “cure” any preferential payments by simply timing your filing correctly.
Let Caldwell Law Firm Help You Plan
The goal of bankruptcy is a fresh start, not a legal battle involving your loved ones. By planning your filing carefully, we can help you navigate these look-back periods and ensure your transition to financial freedom is as stress-free as possible.