Chapter 7 bankruptcy is designed to treat all creditors equally. If a debtor favors particular creditors by paying the preferred creditor just before filing bankruptcy the bankruptcy trustee can force the preferred creditor to give back the money for equal distribution to all the creditors. The look-back period for preferential payments is 90 days for general creditors and one year for creditors who are “insiders.” Most often, the preference issue comes up when a debtor repays a family member or business partner within the one year preference period because the debtor feels a moral obligation to pay the family member or partner ahead of unrelated creditors. This past week a client described a repayment of a loan from a good friend. Debtor and the friend had known each other for over 20 years and had in the past several business dealings, although they were not currently business partners in any venture. The issue presented is whether repaying a loan to a good friend within one year of filing bankruptcy is subject to reversal and recoupment as an improper preference.
I found several cases in Florida and elsewhere dealing with repayment of loans to friends. Most courts agree that whether or not a repayment to a friend constitutes an improper preference depends on the facts of each case and each relationship. The bankruptcy code defines an “insider” as a family member or a closely held business. Most bankruptcy court strictly interpreted the “insider” definition and have held that repayment of loans to friends between 90 days and one year prior to bankruptcy are not preferences. However, some courts have stated that friends are insiders for purposes of preference payments where the debtor and friend are living as a de facto family unit with a romantic relationship or close financial association; payments to live-in boyfriends or girlfriends are preferences. In most cases, the preferential repayment to someone who is nothing more than an unrelated personal friend is not a preference if made more than 90 days prior to filing a bankruptcy petition.