Archives for April 2018

The Surprising Benefits: Resolving the “Preference” Problem through Chapter 13

Avoid the risks or persuading or negotiating with the Chapter 7 trustee by solving your preference problem through Chapter 13. 

 

Our last several blog posts have been about the problem of preference payments:

  • 3 weeks ago we introduced the problem resulting from paying a favored creditor before you file bankruptcy
  • 2 weeks ago we discussed avoiding the problem by delaying filing your case or persuading the trustee to do nothing
  • Last week was about negotiating with the trustee to pay off the preference money yourself

Today we get into how to solve this problem by filing a Chapter 13 “adjustment of debts” case instead of a Chapter 7 “straight bankruptcy” one.

When Filing a Chapter 13 Case May Be Worthwhile

A Chapter 13 case is very, very different from a Chapter 7 one. For starters, instead of taking about 4 months a Chapter 13 case almost always takes 3 to 5 YEARS.  Using it to resolve a preference is almost never a good enough reason to file a Chapter 13 case.

But Chapter 13 CAN be better than Chapter 7 in many situations. It can accomplish a lot that Chapter 7 can’t. So if you already have a good reason or two to consider a Chapter 13 case, using it to solve a preference problem as well may push you in that direction.

Let’s say you have an expensive vehicle loan that you’re a month behind on. Chapter 13 would allow you to cramdown that loan. That would reduce your monthly payments and the total you would pay. Plus you wouldn’t have to catch up on the missed payment. Yet you’re on the fence as you wonder if the disadvantages of Chapter 13 outweigh these savings. So if you have a preference problem that Chapter 13 would deal with, that could push you into deciding on Chapter 13.

When You Really Need to Use Chapter 13

The Chapter 7 solutions don’t always work:

  • You often don’t have the luxury of delaying your bankruptcy filing enough so that more than 90 days has passed after the preferential payment. (Or a full year has passed, if the payment was to an “insider” creditor)
  • The trustee may pursue your previously paid creditor in spite of your bankruptcy lawyer’s efforts to dissuade the trustee.
  • You may not have the ability to pay off the trustee yourself. Or you may owe too much to pay it off fast enough to satisfy the trustee.

So you’re looking to file bankruptcy and your lawyer advises you that none of these three are going to work. Then, if you want to avoid having a Chapter 7 trustee chasing your prior-paid creditor, consider the Chapter 13 solution.

How Does Chapter 13 Fix a Preference Problem?

Chapter 13 solves the preference problem by enabling you to pay the trustee within your payment plan. You pay enough extra money into your Chapter 13 plan to pay what you would have paid a Chapter 7 trustee. But you have significant advantages in doing it this way.

But first an example to show how this works. Assume you paid off a debt of $2,500 to your sister 60 days before filing bankruptcy. You’d gotten a tax refund and she desperately needed the money. You’d put her off for years and then had promised to pay her from the refund. Now you’re about to have your home foreclosed on so you can’t wait to file bankruptcy. If you filed a Chapter 7 case the bankruptcy trustee would force your sister to return the $2,500. She’d get sued if she didn’t. You absolutely don’t want that to happen. So you file a Chapter 13 case—which you be doing anyway to save your home. Your lawyer calculates your Chapter 13 payment plan to pay an extra $2,500 beyond what you would otherwise need to pay. You pay that extra amount over the course of your 3-to-5-year case. This may increase your monthly payment somewhat, or it may extend the length of your case. But your sister would not have to pay back anything. The trustee would have no need to even contact her.

Advantages of Using Chapter 13

1. When you file a Chapter 7 case hoping to persuade the trustee not to pursue your prior payee, you may not know if that’ll work. Or if you hope to negotiate payments to the trustee, you don’t know if that will work. The trustee may want to try to get the money out of your payee after all. Or your trustee may reject your offer in order to get the money faster from your payee. Using Chapter 13 takes away these risks. The system allows you to use your Chapter 13 plan to pay what’s needed.

2. Chapter 13 gives you much more time to pay what you need to pay. A Chapter 7 trustee’s job is liquidation. He or she is under pressure to wrap up your case quickly, and so will pressure you to pay quickly. Ask your lawyer but generally a Chapter 7 trustee won’t give you more than a year to pay up. And he or she may simply require you to pay it all in a lump sum. In contrast, under Chapter 13 you have 3 to 5 years to pay.

3. You have more control over where the money goes, and when. Chapter 13 is often used to pay creditors that you want to or need to pay. For example, if you owe a recent income tax debt or back child support, it’s much better to have those debts paid through a court-ordered Chapter 13 payment plan.

4. You have more control over when debts are paid. If you have a debt or two that needs to be paid quickly, that can often be paid first. For example, if you need to catch up on a car payment (because it doesn’t qualify for cramdown), your plan may front-load money there. The extra money you are paying because of the preference can be put to better use early in your case.

 

The Surprising Benefits: Resolving the “Preference” Problem through Negotiation

Prevent your Chapter 7 trustee from requiring a relative or friend to return your pre-bankruptcy payment by paying the trustee yourself.  

 

Our blog post two weeks ago introduced an uncomfortable problem: preference payments to a friendly creditor. (Please read that blog post before reading this one.) Then last week we discussed two possible solutions to this problem. Today we discuss the first of two other solutions.

The First Two Solutions

One way to avoid this problem is simply to wait long enough so that enough time passes from the time of your payment to your favored creditor to the time you file your Chapter 7 bankruptcy case. That’s because a payment is considered preferential only if you paid it within a specific time period before your bankruptcy filing. That time period is only 90 days, or one year if the payment was to an “insider.” If you file your case after the pertinent time period has passed, the payment is no longer a preference. You’ve avoided the problem altogether.

The second way to solve the problem is for your bankruptcy lawyer to convince your Chapter 7 trustee not to pursue the preferential payment. That is, there are circumstances when it’s not cost-effective for the trustee to make your payee pay it back. Either the amount at issue is too small or the person you paid can’t be forced to disgorge the money.  

But what if neither of these would work? You couldn’t wait long enough to file your bankruptcy case. Or the trustee definitely intends to pursue your payee for the preferential payment. What other options do you have? Here’s a likely solution.

Offer to Pay the Trustee a Reduced Amount Yourself

A Chapter 7 trustee is required by law to gather whatever the law allows him or her to collect in your case. However, in most consumer Chapter 7 cases the trustee collects nothing—your case is called a “no asset” case. That doesn’t mean you have no assets. It means that all your assets are protected (“exempt”), AND the trustee has no right to anything else. On that second point, most of the time there are no preferential payments for the trustee to pursue.

But we’re assuming here that there IS a preferential payment that the trustee has decided to pursue. Let’s say you very much do not want the trustee to do that. You don’t want the trustee to require the person you paid earlier to now pay that money back to the trustee.

So as we said in the subtitle, you could instead offer to pay the trustee that same amount of money yourself.

Why Would You Want to Pay the Trustee Yourself?

Why in the world would you want to do that? You would if it was the best option for you.

Assume that you have very strong feelings against your prior payee being required to pay back the money you’d paid. Maybe you don’t want that person to even know about your bankruptcy filing. You certainly don’t want the bankruptcy trustee to tell him or her now to give the money you paid back to the trustee. You want to do anything to protect that person.

There’s also a good change that if the trustee did make the person pay the money, you’d have to pay the person again. You may well feel a moral obligation to make the person whole, after the trustee makes him or her to give up what you’d previously paid. If so, then you instead just paying the trustee would cost you the same while avoiding the trustee harassing your prior payee.  

Also, there’s a good chance paying the trustee yourself could save you money. There are costs and risks for the trustee in pursuing a preferential payment. If you pay the trustee yourself that would avoid those costs and risks. So the trustee may well be willing to accept less money—the amount it would have received from your payee minus the avoided costs.

Why Would the Trustee Take Your Money Instead of Your Payee’s?

The trustee doesn’t usually care where he or she gets the money from a preferential payment. Whether it comes from your payee paying the money back, or from you, money is money. The trustee can fulfill his or her responsibilities regardless where the money comes from. So, trustees generally are fine with you paying to avoid the trustee shaking down your payee.

However, that’s not always true. For example, most debtors don’t have the amount of money required payable in a lump sum. Often trustees are willing to let you pay the agreed amount in monthly payments. But the full amount has to be paid off relatively quickly. If the trustee has reason to think that money would come quicker from your payee, the trustee may just decide to get it from him or her instead.

Talk with your bankruptcy lawyer to find out the possibilities under your circumstances.

When Is Paying the Trustee Not a Good Idea?

The whole point of this effort is to protect the person you paid earlier. But there are various situations in which this goal does not apply.

You may not want or need to protect this person. You may not care that the trustee makes him or her pay back the money, for emotional or financial reasons. Frankly, you may have had a falling out with the person. Or, he or she may have plenty of money so that paying back the money may not hurt at all.

You may also not need to protect the person because the law protects him or her already.  He or she may have a valid legal defense to a trustee preference action. Bankruptcy preference law is quite complicated. Your bankruptcy lawyer will ask the appropriate questions to determine whether the person you paid may have a defense.

Your lawyer will also discuss whether the person may not need to pay the trustee for other practical reasons. For example, the amount at issue may simply be too small, or the person may be effectively “judgment-proof.” If so, you’d be wasting your money by paying the trustee yourself.

 

The Surprising Benefits: Solving an Uncomfortable “Preference” Problem

A preferential payment to a relative or friend can turn very uncomfortable. But there are some good solutions. One should work for you.

 

Last week’s blog post introduced an uncomfortable problem: preference payments to a friendly creditor. (If you haven’t already please read that one before reading further here.)

The Solutions

We ended that blog post by listing and giving short descriptions of 4 likely practical solutions. We explain the first two of them today and the other two next week.

1. Wait to File Until after the 1-Year or 90-Day Preference Look-Back Period:

There’s one very simple way to avoid having money you paid to a favored creditor turn into a problematic preference.  Wait to file your bankruptcy case long enough so that enough time passes since that payment. Then it’s no longer a preferential payment that the trustee can cause you problems with.

The preference period is only 90 days with most creditors, but a full year with “insider” creditors. Without getting unnecessarily technical, there’s a good chance that anybody you’d have a personal reason for paying is an insider. See Section 101(31) of the U.S. Bankruptcy Code for the statutory definition of insider. But note that this is not a complete list. It says what the term “includes,” but courts have made clear that others not on the list could be insiders. For example, also included could be friends or others who’d you’d have a personal reason to favor over other creditors.

Whether the creditor is an insider or not, the payment you made is not a preference if more than 90 day/1 year has passed when your bankruptcy lawyer files your case. Then your bankruptcy trustee would have no power to require your payee to pay back your payment.

We are well aware that waiting is not a simple solution if you are in a big hurry to file your bankruptcy case.  Waiting even a few days may not be at all easy if your paychecks are being garnished or you’re under other similar collection pressure. Or waiting may even be totally inappropriate if your home would be foreclosed or your vehicle repossessed in the meantime.  

However, there are many situations where you would not be a huge hurry to file your case. Then waiting would be worthwhile. This may especially make sense if you are getting close to 90 day or 1-year mark since your preferential payment. So, at least look into whether you should just wait long enough to avoid the problem altogether.

2. Persuade Trustee Not to Pursue the Preferential Payment:

Just because there was a preferential payment within the look-back period, doesn’t mean it’s worth for the trustee to pursue. There are many circumstances in which you could help convince him or her to let it alone.

First, the simplest situation is if so little money is at issue that it’s not worth the bother. It takes some effort for a trustee to force a preferential payee to pay back the money. There is also a certain amount of paperwork and effort to divvy up the money among your creditors.  If the payment you made is no more than several hundred dollars most likely your trustee will shrug it off. (This is similar to trustees generally not chasing an unprotected (“nonexempt”) asset: if it’s only worth a few hundred dollars it’s usually not worth collecting and distributing.) Talk with your bankruptcy lawyer about what that unstated threshold dollar amount would  be in your area.

Caution: IF the trustee is already collecting assets in any form in your case, this threshold amount consideration likely goes out the window. If the trustee already has to liquidate anything and distribute money to creditors, he or she will usually be inclined to add to that amount by chasing down your preferential payee.

Second, there are many circumstances where forcing a preferential payee to repay the money would be difficult for the trustee. Your payee may have very little in assets or income reachable by the trustee, so it would likely take a very long time to collect it. Or the payee may have a valid defense. Especially if the amount at issue is relatively small (although above the above threshold), the trustee may decide such preferential payments are not worth chasing.

Third, there are other circumstances where the trustee simply could not collect from your payee at all. Your payee may have disappeared and can’t be located. Or your payee may be legally “judgment-proof”—have no assets or income reachable by the trustee. Helping the trustee learn the true facts along these lines could induce him or her make a sensible decision to abandon the preferential payment.

 

The Surprising Benefits: A “Preference” Payment to a Relative or Friend

A preferential payment to a favored creditor—a relative or friend—can be a problem, but one which usually has a workable solution. 

 

Our last two blog posts have been about one of the more confusing parts of bankruptcy: the law of preferences. This law says that if a creditor takes or receives money from you within the 90 days before you file your bankruptcy case, the creditor may need to pay it back. A creditor would not pay that money to you but rather to your Chapter 7 bankruptcy trustee. The trustee would then pay out that money to creditors based on a priorities schedule in bankruptcy law.

Our last blog post was about how that priority schedule could result in most of that money going to a creditor you need and want to be paid. One example we used was a recent income tax debt. That can’t be discharged (written off) in bankruptcy. So preference law could result in the trustee getting some money back from a creditor you don’t care about to pay the tax debt so you don’t have to.

Preference Payments You DON’T Want Undone

But preference payments don’t just involve creditors you don’t care about. You may well not lose sleep over a trustee forcing a credit card company to return $1,000 it garnished from you on the eve of your bankruptcy filing. But what if you’d paid $1,000 on a personal loan to your brother or grandmother 6 months before filing bankruptcy? You’d promised to pay him or her back as soon as you got your tax refund, for example. So you did pay the $1,000. He or she really needed the money, and you felt huge emotional and ethical pressure to pay it. It was the right thing to do.

But now you hear from your bankruptcy lawyer that a Chapter 7 trustee could force your brother or grandmother to pay back that money. You feel that would be crazy, and wrong. Your brother or grandmother has long ago spent the $1,000 you paid on the loan. It would really be hard on them to now turn around and pay $1,000 to your trustee. In fact maybe one reason you paid off this debt was so that he or she would not be involved in your anticipated bankruptcy case. You may prefer that your relative not find out about you having to file bankruptcy. You can’t think of anything worse than he or she getting a demand from the trustee to pay the $1,000. This prospect may well turn you off about filing bankruptcy altogether.

The Solutions

However, this problem has a number of likely practical solutions. We’ll list them here and give brief explanations. Then next week we’ll expand on them to make sure they make sense.

1. Wait to File Until after the Preference Look-Back Period: With “insiders”—relatives and potentially anybody close to you–the look-back period is a full year before filing. It’s not just 90 days back, as it is with non-insiders. Regardless, especially if you are getting close to a year since your preferential payment, consider waiting long enough to avoid the problem altogether.

2. Persuade Trustee Not to Pursue the Preferential Payment: Your relative or other favored person that you paid may genuinely be unable to pay the $1,000 or whatever you paid. He or she may have no legally reachable income or assets. The trustee won’t want to waste money to pay his or her lawyer to fruitlessly pursue a preferential payment.  

3. Offer to Pay the Trustee a Reduced Amount Yourself: The trustee will usually not care where the preference money comes from—from the relative or other creditor who got your money, or anywhere else. So you could offer to pay that $1,000 or whatever that sum of money yourself. The trustee may even take monthly payments from you. Also, he or she may accept less than the full preference payment amount, subtracting what it would have cost in attorney fees and other costs for him or her to get it from your relative.

4. File a Chapter 13 Case to Prevent Pursuit of the Preferential Payment: Chapter 13 “adjustment of debts” often provides a very good solution. It works particularly if 1) you need to do a Chapter 13 anyway, 2) the preferential payment is large, and/or 3) none of the above solutions will work.

Next Time…

We’ll explain these four in our next blog post. The bottom line until then: a preferential payment to a relative and other favored creditor can be a scary problem, but it’s one that usually has a very sensible practical solution.

The Surprising Benefits: Use “Preference” Money to Pay a Favored Debt

When a creditor is forced to pay back recently received money through “preference” law, that money can go to pay a debt you want to be paid. 


Last week we introduced the law of preferences. This law says that if a creditor takes or receives money from you within the 90 days before you file your bankruptcy case, the creditor may need to pay it back. There are some complicated conditions that may apply, but in many situations the creditor does need to pay it back. See Section 547 of the Bankruptcy Code.

We ended last week by asking where this returned money goes. What good does it do you if that money just goes to your Chapter 7 trustee?  After all, this liquidating trustee’s job is to distribute that money among all your other creditors. So how does that help you?

Chapter 7 Trustee’s Collection of Bankruptcy Assets

It’s true that under Chapter 7 “straight bankruptcy” it’s your bankruptcy trustee who makes a creditor return a “preferential payment.” The Bankruptcy Code says “the trustee may avoid” a preference payment. It’s not you, the debtor, who has that role. Section 547(b). (“Avoid” means requiring the creditor to pay the recently received money back, but to the trustee.)

That returned money then goes into the pool of money the trustee uses to pay your creditors. In most consumer Chapter 7 cases that’s the only money available to the trustee. That’s because everything that most debtors own is protected through property exemptions. Exemptions are categories and maximum amounts of assets that you can keep in bankruptcy under state and/or federal law. So, when a trustee avoids, or undoes a creditor’s preferential payment, that money is all the trustee has to work with.

Whether the trustee only has the preference money or also liquidates an unprotected asset, what happens to the resulting money?

Chapter 7 Trustee’s Distribution of Bankruptcy Assets

Once the trustee has received the preference money (plus any other money from liquidating assets), he or she is required by law to then distribute that money in a very specific way. The law is laid out in the Bankruptcy Code’s Section 726, “Distribution of property of the [bankruptcy] estate.”

The distribution rules say that “priority” debts get paid in full before anything goes to any other debt.  Section 726(a)(1) says the money first goes to debts under Section 507, which are a listing of the priority debts.

When an “Avoided Preference” Directly Benefits You

Simply put, if you want or need to pay a debt that’s a “priority” debt, the trustee will pay it. The trustee will pay it out of the money it got from the creditor by “avoiding” the preference payment. The trustee will pay your favored priority debt before paying any other debt.

For example, an unpaid child support payment or recent income tax debt would be a priority debt. These debts could not be discharged—legally written off—in a bankruptcy case. So you’d have to pay them after your Chapter 7 case was completed. But the trustee would pay such a debt from the preference money. That would either eliminate or reduce what you’d have to pay yourself.

If your priority debt that you’d like to be paid is larger than the amount of money the trustee has from the preference, the trustee would only pay part of that priority debt. If the trustee has more than enough money, he or she would pay off the whole priority debt.

(The trustee also gets paid a fee out of the same money, so you need to take that fee into account. The fee is based on a sliding scale: a maximum of 25% on the first $5,000 distributed, 10% on the next $45,000, etc. See Section 326(a).)

Conclusion

Preference law can make a creditor give up money it took from you shortly before you filed your bankruptcy case. Then this same money can instead go to pay a priority debt which you very much want to get paid.

This is quite a nice benefit of bankruptcy. You can force one of your less important creditors in effect to pay your most important creditor!