Filing for bankruptcy can bring relief from overwhelming debt, but many people worry about how it will affect debts owed to loved ones. Personal loans from friends or family members are treated differently than institutional debts by the bankruptcy court, more akin to other unsecured debts. Understanding these nuances is important for both the debtor and the person who loaned the money. Continue reading for more information and contact a skilled Shelby County, TN bankruptcy lawyer today.
What Happens to Personal Loans from Friends or Family in Bankruptcy?
When you file for bankruptcy, you will need to list all of your creditors, including friends and family members from whom you’ve borrowed money. Legally, these personal loans are treated as unsecured debt, similar to credit card balances or medical bills, unless the loan was secured by collateral, like a car title or a home mortgage.
Understanding how these loans are handled is crucial when filing for bankruptcy. Consider the following.
- Chapter 7 Bankruptcy (Liquidation): Debts to friends and family are typically discharged along with other unsecured debts. This means the debtor is no longer legally obligated to repay the loan. While the legal obligation is gone, many debtors still feel a moral obligation and choose to repay these loans voluntarily after the bankruptcy case is over. However, any repayment made before filing can be scrutinized by the court as a preferential payment.
- Chapter 13 Bankruptcy (Reorganization): In a Chapter 13 plan, unsecured creditors, including friends and family, generally receive only a fraction of the debt owed, based on the debtor’s income and assets. The plan must treat all unsecured creditors the same way. The court will not allow the debtor to create a plan that prioritizes a friend or family member over institutional creditors.
What is the Risk of Preferential Payments?
A preferential payment, or preferential transfer, occurs when a debtor repays one creditor shortly before filing for bankruptcy, while neglecting other creditors. Bankruptcy law allows the trustee to take back these payments to ensure all creditors receive equal treatment, preventing unfair favoritism toward insiders.
A significant issue arises if the debtor paid back a substantial amount to a family member or friend shortly before filing. Payments totaling more than $600 made to “insiders” (which includes family members) within one year of filing bankruptcy can be recovered by the bankruptcy trustee. This is because the law aims to ensure all creditors are treated equally, and paying a loved one back while excluding others is considered a preference. The trustee may sue the family member to recover the money and distribute it among all creditors.
Bankruptcy law can be complex, so it is highly recommended that you secure the help of an experienced attorney. Contact a legal professional at the Arnold Law Firm today.
