No one wants to shortchange a family member. But if you file for Chapter 7 bankruptcy when you owe money to family member, you face certain pitfalls you need to be aware of. For instance, let's say your Aunt Betty loaned you $2,000. If you file for Chapter 7 bankruptcy, you must list that debt along with all of your other debt. And the law will not let you give any preference to your Aunt Betty. In fact, the law goes out of its way to ensure that you treat your debt to Aunt Betty the same as you treat all of your other creditors.
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In order to ensure that all of your creditors are treated equally, the law forbids you from paying more than $600 to any creditor that is deemed an "insider" for the year prior to your filing for bankruptcy. For purposes of bankruptcy law, an "insider" is normally defined as a relative, business partner, or a friend. If the bankruptcy trustee learns of a payment made to an insider exceeding $600, it can take the money back from the insider and distribute the funds equally to your creditors. The justification for this rather draconian result is that the bankruptcy law wants to ensure that all of your debtors are treated equally. And if given the chance, most people would prefer to pay their friends and family long before they pay Visa and American Express. If a bankruptcy trustee reaches back and takes money from one of your family members because they received a preferred payment, that could make your next Thanksgiving dinner quite uncomfortable.
It is important that when you talk to your attorney you disclose any payments you made to insiders during the prior year. There are a few exceptions to the insider rule and your attorney can help you determine if your payment qualifies as a preferred payment to an insider. Take heart, even if your debt to your relative is discharged, that does not doom your Thanksgiving dinner. Nothing is preventing you from paying your relative back after you file for Chapter 7 bankruptcy. Just make sure you pay back any loan with money that is not part of the bankruptcy estate. Talk with your attorney to ensure that you are complying with the law before you make any payments to an "insider". Holiday gatherings can be stressful enough without bankruptcy induced fireworks.
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