When you file for bankruptcy relief, you hear many terms that might not be familiar, or the terms might have meanings you did not expect. One of those terms is “preference payments.”
What Are Preference Payments?
A preference or preferential payment is a payment made to the creditor before you file your Chapter 7 bankruptcy petition. Preference payments give the creditor more money than they would receive through your Chapter 7 bankruptcy case.
In a typical Chapter 7 bankruptcy case, the Chapter 7 trustee examines the debtor’s (your) assets. The trustee can seize or claim any non-exempt assets for the bankruptcy estate. Then, the trustee sells the assets and uses the money to pay creditors in the bankruptcy estate who do not have collateral for the debts you owe (i.e. unsecured creditors).
Unsecured creditors include, but are not limited to:
- Credit cards
- Personal loans
- Most personal judgments
- Old lease or rental payments
- Medical bills
Some debtors can discharge student loans and older income tax debt. However, they must meet specific and strict requirements to discharge those debts. Generally, people get rid of thousands of dollars in debts they cannot afford to pay when they file a Chapter 7 case.
Try our free chapter 7 bankruptcy calculator below to learn if you could qualify to file bankruptcy under Chapter 7.
Why Does It Matter if a Person Pays Off Debt Before Filing Chapter 7?
Preference payments cheat other creditors out of money they would have received from the Chapter 7 bankruptcy. For example, suppose you sold your car that was paid in full and paid off a credit card that your mother co-signed before you filed Chapter 7. You did not want your mother to be responsible for the debt.
However, the vehicle would have been an asset of the bankruptcy estate. The Chapter 7 trustee would have sold the car and used the money to pay unsecured debts. The credit card company would have received pennies on the dollar for the debt, but so would the other unsecured creditors. By selling your car and using the money to make preferential payments, you cheated your other creditors out of money they should have received.
How Does the Chapter 7 Trustee Know I Made a Preference Payment?
Your bankruptcy schedules are signed under oath. The Chapter 7 trustee also asks you questions during the 341 Meeting under oath. You are required to disclose payments and transfers before filing for bankruptcy.
Therefore, if you made a large payment to a creditor, relative, friend, or another person before filing bankruptcy, you must disclose that payment. Likewise, you must disclose the transfer if you sold or transferred assets before filing bankruptcy.
The amount of the payment or transfer and the timeframe determines the disclosure requirements. Preferential payments in bankruptcy include, but are not limited to:
- $600 or more to unsecured creditors within 90 days of filing bankruptcy
- Money paid to an insider within 1 year of filing bankruptcy (insiders include family members, friends, business partners, etc.)
- $7,575 to a single creditor if the debtor is a business
Payments for ongoing living expenses generally do not count as preference payments. For example, car loans, mortgages, leases, utility bills, and support payments should not count as preferences.
The law regarding preference payments can be confusing. If you believe you made a preference payment, talk to a Chapter 7 bankruptcy lawyer before filing for bankruptcy. Ascend helps you find a bankruptcy attorney near you who offers free consultations.
What Happens in My Bankruptcy Case to Preferential Payments?
A Chapter 7 trustee can recover preferential payments so the funds can be distributed to unsecured creditors based on bankruptcy laws. An adversary action for a preference payment gives the trustee the ability to “claw back” the preference payment if the trustee proves:
- The payment was made to a creditor or an insider;
- For a debt owed by the debtor;
- While the debtor was insolvent;
- During the preferential payment period; and,
- Allowed the creditor to receive more than they would have received in a Chapter 7 liquidation.
Adversary proceedings are lawsuits filed within a bankruptcy case. The trustee files a lawsuit against the person who received the preferential payment. However, most Chapter 7 trustees begin by writing a letter to the party demanding the return of the preference payment.
Sometimes, a trustee might work with an individual to give them a short period to pay the money to the estate. However, if the person refuses to turn over the preferential payment to the trustee, the trustee continues with the adversary proceeding.
If the court rules in favor of the Chapter 7 trustee, it enters a judgment against the party who received the preference. The Chapter 7 trustee can pursue legal action to collect the judgment.
Are There Ways to Avoid the Chapter 7 Trustee From Trying to Claw Back a Preferential Payment?
Call Ascend if you made preference payments and need to file a Chapter 7 bankruptcy. We can put you in touch with a bankruptcy lawyer to discuss your case. There could be one or more things you can do to avoid the problem, such as:
- Wait until the preference period passes to file bankruptcy
- File a Chapter 13 bankruptcy and include the preference in your Chapter 13 plan
- Arrange to reimburse the bankruptcy estate for the preference payment
There could be one or more defenses to allegations of a preferential payment. A skilled bankruptcy lawyer assesses the situation and advises you of your options so you can make an informed decision on how to deal with the matter.
Will a Chapter 7 Trustee Take All of My Property to Repay Debts?
It is frightening to think about a Chapter 7 trustee liquidating your assets to repay debts. The fact is that most people who file for Chapter 7 relief do not have assets that they could use to repay their debts. Most people have already liquidated their assets trying to pay living expenses and debts. In a majority of Chapter 7 cases, the debtors do not lose property.
Also, Federal bankruptcy laws allow debtors to claim a specific amount of their assets as exempt. Exempt equity cannot be used to repay debts. In other words, the court nor your creditors can seize and sell an exempt asset.
For example, suppose your vehicle is worth $4,400 after subtracting the payoff of your car loan from the fair market value for your vehicle. The federal bankruptcy exemption in 2023 for a vehicle is $4,450. Therefore, there is no equity in your vehicle:
Fair market value of vehicle = $26,000
Less payoff to Car Lender $21,650
Equals net equity $4,350
Less federal exemption $4,450
Net equity in vehicle $0.00
Because the equity in your vehicle is less than the federal bankruptcy exemption, there is no equity in your vehicle for the Chapter 7 trustee to use to pay your unsecured creditors.
If you are concerned about losing your property if you file Chapter 7, try our free bankruptcy exemption calculator to get an idea of how Chapter 7 bankruptcy would impact you.
You can also use our free debt relief calculator to compare debt relief options. Do you have debts you cannot afford to pay? If so, help is available. Ascend provides support and guidance as you work through your debt problems.
Get Help With Debt Problems Today!
At Ascend, we help individuals find a way out of debt. For more information about debt relief options, call or text us at (833) 272-3631 or contact us online for a free case evaluation.
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