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Doing the right thing (like paying off debt) is not always the right thing.

Posted by Brian Hallaq | Mar 22, 2022 | 0 Comments

One of the great frustrations of filing for Bankruptcy is that many of the rules are counter-intuitive.  People want to do the right thing and in the case of debt that means paying off bills.  When people pay debts, it is a function of having money and who you want to pay.

Obviously, people close to you deserve your resources.  After that, oftentimes people pay either the creditor that is screaming the loudest, or a creditor whose debt is small and manageable.

The problem is when you eventually file for Bankruptcy, your history of payments to creditors is examined closely in your Statement of Financial Affairs.  “Insider” creditors are friends, family members, and business partners, and those payments are examined for up to one year leading up to the Bankruptcy case.  “Ordinary” creditors are all other creditors, such as credit cards and medical bills and are examined for any payments in the 90 days leading up to the filing of the Bankruptcy.

So, what this means is that when you pay someone you owe money to, you have to disclose those payments to the Bankruptcy court.  This part can be a bit confusing, because obviously you are constantly paying some type of obligation, such as your rent, cell phone bill, and utility bills.  Those types of obligations do not need to be disclosed if the payment is for “current” or contemporaneous transactions.  But you have to disclose them for any payments where you were carrying a balance.

So, for example, let's say you are current on your cell phone bill, and you receive this month's bill.  Paying that bill is just fine and doesn't need to be disclosed to the Bankruptcy Court because it is for this month's services.  On the other hand, let's say that you are three months behind on your electric bill.  If you make a payment on that bill, it would have to be disclosed to the Bankruptcy Court.

So, what happens when those transactions are disclosed?  Sometimes it doesn't mean anything, but in other situations, the Bankruptcy Trustee in a Ch. 7 Bankruptcy can reach out to those creditors and take that money back in order to redistribute it as part of your Bankruptcy case.

For example, we recently had a client who worked for a company that also had an affiliated credit union.  Because she was worried about how it might look to her employer if she declared Bankruptcy and that her loan balance to the credit union would be discharged, she decided (prior to speaking to me) to pay the balance off.  Unfortunately for her, after filing for Bankruptcy, the Trustee went to the credit union and recovered that payment in order to redistribute it to all of her creditors.

The situation is scrutinized even more when the creditor that you pay is an “insider”, such as a family member.  The lookback period is longer (one year), and the circumstances are more likely to result in the Trustee trying to recover the funds, because transactions with friends and family members are always considered to be suspect by the court.

Why does the Bankruptcy Court seem to punish ordinary people for doing what seems to be the right thing?  What you have to understand is that these rules were created with entirely different people in mind.  Years ago, the corrupt New York stockbroker would invent a debt to his brother, and then prior to filing for Bankruptcy he would “pay” that debt off, which was really a way to shelter a huge amount of money, which would eventually come back to him after the Bankruptcy case is done.  Congress was trying to prevent such corrupt practices, but these rules ended up being applied to normal people like you.

So, the bottom line is that paying a creditor, which is ordinarily a good and moral thing, can backfire on you if you file for Bankruptcy.  For this reason, you need to coordinate with your Bankruptcy attorney before you make any payments on any debts for which you are carrying a balance.  If you pay a bill for which you are carrying a balance, you run the risk that the Bankruptcy Trustee undoes that transaction and your payment doesn't accomplish what you wanted.  As always, your Bankruptcy attorney is going to be your best resource on your actions, especially prior to filing for Bankruptcy.

About the Author

Brian Hallaq

My name is Brian and I have been a practicing attorney in Bankruptcy for over 20 years helping thousands of clients.  I have worked for the Chief Judge of the United States Bankruptcy Court for the Western District of Washington, as well as several small boutique Bankruptcy law firms handling Bankruptcy cases in Washington State and the State of California.  I have litigated for and against major banks, and I have recovered millions of dollars on behalf of clients in my career.

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