If you’re like many of my clients, the decision to file bankruptcy has been one that you have been trying to put off. Although you’ve been struggling with your bills, you’ve been making ends meet and keeping debt collectors away. Again, if you’re like many of my clients, one of the ways you’ve been able to do that is with a loan from a family member.
One of the most important questions I ask during my initial consultation with a prospective client is whether or not they have gotten, or are paying back, a loan from a family member. Loans from family members can have important consequences in bankruptcy, some of which are legal, and some of which are not.
The first thing I tell my clients is that any loan from a family member must be included on the bankruptcy petition. As you can imagine, they aren’t real happy to hear that. But there are a couple of reasons for this advice. First, the Bankruptcy Code requires all debts to be listed. Second, the purpose of bankruptcy is to eliminate any debts my client has. I understand that of all the debts they have, they will want to make sure they pay their relative back. And they can. There is nothing that prohibits you from paying back a loan that you have included in your bankruptcy petition. Including it protects you in case something happens that prevents you from paying it back, such as unemployment or disability. I tell my clients that they should talk to their relative before they file their petition, so that no one is surprised by the notice of the bankruptcy from the court.
The other thing that I have to tell my clients about loans from relatives is the look back period for payments made to creditors who are considered “insiders”. Family members fit squarely within the Bankruptcy Code’s definition of “insider”. As such, my client has to disclose any payments that have been paid for a loan from a relative within the last year, if the total amount is more than $600.00.
It’s possible that the trustee will want this money back from the relative so that she can distribute it to other unsecured creditors. If that happens, of course the relative will be out of the money that you paid back, and you might have to pay the relative back again. This isn’t a great outcome for anyone, of course. And there is no guarantee that the trustee will ask for the money back. Nonetheless, the best course of action – the ONLY course of action – in bankruptcy is to disclose everything. Having to deal with an unhappy relative is probably a better alternative to having your bankruptcy case dismissed.