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.