The bankruptcy trustee wants payment for a preferential transfer to an insider. What do I do?

If you paid back a debt to a relative or friend within one year of your bankruptcy, the trustee may try to get that money back. Here's what you can do if that happens.

If you paid money or transferred property to a relative, friend, or business associate (an "insider") as payment of a debt within one year prior to your bankruptcy filing, the bankruptcy trustee may be entitled to get that money back and add it to your bankruptcy estate. In bankruptcy-speak, this is called a preference transfer. (For details on how this works, see Pre-Bankruptcy Payments to Creditors: Can the Trustee Get the Money Back?.)

Strictly speaking, the issue of the recovery of a preferential transfer by a trustee from an insider is between the trustee and the insider. As the bankruptcy debtor, it is not likely that you will be a party to that action or that discussion, and you have no legal obligation to pay any money back to the trustee to compensate for the transfer.

But what if you feel a moral obligation to resolve the issue so that the insider, who might be a parent or other close relative or friend, does not have to give the money or property back? What you can do differs depending on whether you have filed a Chapter 7 bankruptcy or a Chapter 13 bankruptcy.

Resolving an Insider Preference Claim in Chapter 13

In a Chapter 13 bankruptcy, you will need to do two things.

First, you will need to add the amount of the preferential transfer to the amount you are paying creditors under your Chapter 13 plan. As you are required to pay all of your disposable income into the plan, this might be difficult unless you can get contributions from a spouse or other source, or use otherwise exempt assets.

Second, both you and the insider who received the transfer will need to enter into a tolling agreement with the Chapter 13 trustee. Under the bankruptcy laws, only the trustee can sue to recover a preferential transfer and trustees have two years to do this or the action is forever barred.

What is a tolling agreement? By entering into a tolling agreement, you effectively suspend ("toll") the time period for the trustee to file suit until your Chapter 13 plan is paid in full. Once your plan is paid in full, the preference will be satisfied and the trustee will have no further claim. But with the tolling agreement, if you do not complete your plan payments and convert your case to a Chapter 7, the Chapter 7 Trustee will still have time to pursue recovery of the preferential transfer to the extent that it was not paid in the Chapter 13.

Resolving an Insider Preference Claim in Chapter 7

In Chapter 7 bankruptcy, your options for dealing with insider preference claims are limited. The only way to stop the trustee from suing the insider is to settle with the trustee directly. This would involve paying the amount of the transfer, or some other agreed upon settlement amount, to the trustee in satisfaction of the claim against the insider.

In order to do this, you'll have to use income you've earned after you filed for bankruptcy or exempt assets. Or, you can get financial help from a non-filing spouse or some other person. Sometimes, the trustee will let you pay the insider preference amount through a short payment schedule -- whether you can do this is in the discretion of the trustee and the bankruptcy court.

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