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Would you like to repay Aunt Sally before filing bankruptcy? Read this first.

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The whole issue of whether you should repay someone to whom you owe money before you actually file for Chapter 7 bankruptcy is more complex than it looks at first glance. I introduced the issue in a previous post about repaying debts before bankruptcy, but there is a lot of detail here that is worth examining.

You may recall from my previous post that if you repay someone you owe money (whether it’s American Express or your Aunt Sally) just before filing for bankruptcy, and the total repayment is $600 or more, the bankruptcy trustee could take back that money from your creditor.

The trustee will look back only 90 days before your filing to see if you repaid any ordinary creditors, such as American Express. But for creditors like your Aunt Sally, the trustee will look back a year before your filing for repayments that they can take back. If the trustee finds loan repayments and takes them back, they can be used to repay your other creditors. The money doesn’t go back to you.

A loan repayment made before bankruptcy that the trustee can take back is known as a “preference” or a “preferential transfer.”

But even when the trustee decides that a payment made to a creditor before a bankruptcy filing was a preference that they can take back, there are defenses that might be applicable. Two of these defenses are: 1) The earmarking defense and 2) The new value defense.

The earmarking defense is available when someone provides you with money to re-pay one of your existing creditors.

In a recent decision the Third Circuit Court of Appeals found that certain things need to be present for the earmarking defense to work: 1) An agreement between you (the debtor) and the person providing you with the money stating that the new money will be used to pay the prior debt; 2) Performance of the terms of the agreement; and 3) This transaction does not reduce the value of the debtor’s estate.

The idea behind the earmarking defense is that the debtor never had an interest (in the sense of a property interest) in the funds to begin with.

The second defense is the “new value” defense. In the same decision mentioned earlier, the Third Circuit said that for the new value defense to apply, you need: 1) A preferential transfer; 2) After receiving the preferential transfer, the creditor makes a new loan to the debtor – this new loan must be unsecured; and 3) As of the bankruptcy filing date, the debtor has not yet repaid the new loan to the creditor.

An example of when the new value defense is available would be when you repay your Aunt Sally the $2500 she loaned you and then your Aunt Sally makes a brand new $2500 loan to you that you had not yet repaid by the time you filed for bankruptcy. It’s basically like reversing the loan repayment.

The Third Circuit decision I referred to above is Shubert v. Lucent Techs. Inc. (In re Winstar Communs., Inc.), 554 F.3d 382 (3d Cir. 2009).

If all this is confusing to you and you don’t know what to do, remember this: Seek advice from a bankruptcy attorney before repaying any loans to anyone in any amount, whether it’s American Express or your Aunt Sally or anyone in between! If you’d like, give me a call at 201-676-0722.

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The 4 Biggest Bankruptcy Myths

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You shouldn’t file for bankruptcy, ever. That’s what the conventional wisdom seems to say. But is this true? Here, I look at the 4 biggest bankruptcy myths faced by most people who are considering filing for bankruptcy.

You need to do what’s right for you. If filing for Chapter 7 bankruptcy turns out to be the right thing for you, then do it. Don’t let the naysayers get in your way.

Because here’s the thing: Each and every person who is having problems with debt needs to do their own analysis, preferably after consulting with one or more professionals, to determine whether Chapter 7 bankruptcy is right for them. Blanket negative statements about the evils of bankruptcy don’t help with your analysis.

Let’s look at these bankruptcy myths one at a time:

  1. You’ll ruin your credit score. If you’re having bad debt troubles, your credit score is probably not good. But maybe you’re still current on all your credit cards. Where that’s the case, your credit score has to go down if you truly cannot afford to pay your debts over the long haul. Don’t worry, there’s a way to improve your score.
  2. You won’t be able to get a new job. Yes, many employers run credit checks on prospective employees. But many employers do not. Sometimes it depends on what industry you are in. Trying to get a bank job? Banks will probably run credit checks on prospective employees. But many “mom-and-pop” small, non-corporate employers do not. In other words, this is a factor you should consider, but it may not be the end all, be all factor that decides whether or not you file.
  3. You won’t be able to rent an apartment. Here again, some landlords run credit checks and some do not. You probably won’t have your pick of every single new apartment to move into, but you wouldn’t have anyway, because some apartments rent for more than you can afford. This factor depends a lot on what’s available in the area where you want to live. So it’s something to consider, but it’s not the only factor (and not even a huge one, at that).
  4. Utility companies will make you put down a deposit. Utility services cannot be cut off because you filed for bankruptcy. If you owe a past debt to a utility, then you may have to put down a deposit after you file. This is why it’s a good idea to be current on your utility bills prior to filing for bankruptcy.

If you’d like help looking into whether bankruptcy is right for you, call (201) 676-0722 to schedule a free phone appointment with attorney Jennifer Weil.

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