Filing bankruptcy doesn’t just stop creditors’ present and future collection efforts against you. It might recoup money you’ve already lost.
The last blog post was about the “automatic stay,” the powerful tool for stopping virtually all actions against you by your creditors. This tool goes into effect immediately when your bankruptcy case is filed. But what if a creditor grabbed a bunch of your money, or some other asset, in the hours, days, or weeks BEFORE you filed bankruptcy? In certain circumstances the creditor can be forced to give up even such previously taken money or asset.
Fairness Among Your Creditors
When you’re considering bankruptcy and wondering about what happens in a bankruptcy case, it’s natural to focus mostly on your relationships with your creditors. You wonder whether you can discharge (legally write off) a particular debt, whether you can keep the collateral on a vehicle loan or mortgage, how you can pay a debt you can’t discharge like a recent income tax, and such.
But much of bankruptcy law actually focuses on the relationships among your creditors, particularly about maintaining fairness among them. One of the main purposes of bankruptcy law is to treat similarly situated creditors the same, to not play favorites unless there is a legally appropriate reason to do so (life if the creditor has some collateral).
This principle of fairness among creditors is the purpose of one of the most misunderstood parts of bankruptcy—the law of “preferences.”
Slapping Overeager Creditors
Preference law aims to help creditors be treated fairly not just DURING your bankruptcy case but also for a certain amount of time BEFORE the filing of your case. The way this is accomplished is that a creditor which grabbed money or some other asset from a debtor within a certain amount of time before a bankruptcy filing can be forced to repay that money or to return that asset.
The Preference Law
Specifically, if a creditor takes money or some asset from you in payment of its debt, within the 90 days before your bankruptcy is filed, and that payment results in that creditor receiving a greater share of its debt than the rest of your creditors, then once you do file bankruptcy that creditor is required to give the money or asset back. Whether the money or asset was taken from you involuntarily or you paid or transferred it voluntarily does not matter. It’s a preference that can be “voided”—the creditor can be required to return the money or asset it received.
But when the creditor returns the money or asset, it does not come back to you but rather to your bankruptcy trustee, to be distributed among your creditors according to the rules for that purpose. The distribution rules can often do you some good.
When an “Avoided Preference” Does You Some Good
It’s the trustee’s job, not the debtor’s, to make the creditor “return” the money or the asset. Then once the trustee has it, he or she is required by law to then distribute that money in a very specific way, in particular, to pay “priority” debts first before paying anything to your “general unsecured” debts. IF you do owe “priority” debts, you likely would WANT them to be paid, because they are usually debts that are not discharged in bankruptcy you have to pay on your own anyway. These debts are often owed to very aggressive creditors that will cause you grief if you don’t pay them. “Priority” debts for consumers primarily include back child and spousal support and income taxes.
Simply put, preference law can make an overeager creditor give up money it grabbed from you shortly before your bankruptcy case was filed, so that this same money can now instead go to pay a special creditor which you very much want to be paid. What can be better than having one of your less important creditors make a payment to your most important creditor!