Most debtors don't own much more than their exempted property at the time of discharge, and most bankruptcy cases don't involve large transfers of money or property during the time prior to the bankruptcy filing. However, it does happen, and a debtor is required to list on his bankruptcy petition forms all transfers of assets or payments valuing more than $600 during the one year prior to filing. Using the "preference avoidance powers," a bankruptcy Trustee can recover or "avoid" certain types of transfers or payments. [ See, 11 U.S.C.A. sec. 547(b) ]. Usually, people who owe debts to family members, for example cash loans made during hard times, would naturally want to pay those loans back, either in full or to the extent possible, with the money that they do have prior to filing for bankruptcy. However, doing so would give that family member preferential treatment over other creditors, like a bank or credit card company, who would otherwise share in that money on a pro-rata basis.
A debtor's family members are considered "insiders" and payments or transfers to them during the twelve month period prior to the bankruptcy filing fall within the Trustee's avoidance or "claw back" powers. With certain exceptions, for example money transferred pursuant to a child support order or which totals less than $600, any such transfers may be avoided. That is, the Trustee will be able to recover it. The property that is recovered, or avoided, is placed into the debtor's bankruptcy "estate" for pro-rata distribution to the debtor's unsecured creditors (see "Exemptions" for further explanation of a bankruptcy estate).
Whether a Trustee can successfully recover or avoid certain kinds of transfers can be a complicated question, for example, determining who exactly is an "insider" or "family member" for purposes of the one year statutory period for recovery. Furthermore, payments or transfers already made by the debtor prior to filing for Chapter 7 bankruptcy may be a consideration in deciding when to file for bankruptcy. That is, if the payments are outside of the one year pre-filing time frame, then the Trustee will not have the authority to void or avoid those transfers. Thus, it may be in the debtor's interest to hang on a little longer before filing for Chapter 7 relief if this helps ensure that the family member will not be required to surrender the money or property already received.
Generally, when a person files Chapter 7 bankruptcy, the issue is one of insolvency: the person's total debt is more than the total value of his non-exempt assets if they were sold to pay the debt. A person may still be employed and receiving income during a period of insolvency. So, many consumers continue to stretch their income to the extent possible, including paying as many creditors as they can prior to filing for bankruptcy. This includes paying back family members, like parents or siblings, who loaned them money. Many debtors contemplating bankruptcy would like to pay back their family members first, or certain other preferential creditors, before filing for bankruptcy. However, in a Chapter 7 bankruptcy the Trustee appointed to the case will investigate your transfers or repayments made prior to the filing (it is unlawful to not list all such transfers over $600), and could demand that the family member or other creditor return the property. This is called the Trustee's "avoidance power," often referred to as a Trustee's power to "claw back" transfers made prior to filing.
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