Most folks considering bankruptcy know about the 90 day rule in bankruptcy.
They’ve talked to friends or read on the internet.
When they get to a bankruptcy lawyer’s office, they’re eager to tell me they know about the rule, though sometimes they have questions about just how it works.
- Some think the rule is one prohibiting paying any bills during the run up to bankruptcy.
- Others think it is a rule against buying anything.
- Some are simply unclear how it works.
Which is all very interesting, except that there is no 90 day rule.
Or at least, no rule that makes any difference to debtors.
Bankruptcy 90 day rule affects creditors
The only bankruptcy rule with a 90 day scope is a rule that allows a bankruptcy trustee to recover money from creditors.
Section 547 of the Bankruptcy Code empowers a trustee to sue creditors that the debtor paid during the 90 days before the bankruptcy case was filed. The goal is to recapture any unfair advantage that creditor got. The debt may be legitimate, but payment gives one creditor a larger share than other creditors.
These payments are termed preferences.
Since most individual bankruptcy cases are no-asset cases in which there is nothing to distribute to creditors, the rule could cover most payments that a debtor makes before filing. Anyone who got some payment got more than others will get through the case.
Preference defenses, the real and the practical
But wait. Just because the debtor paid a bill in the 90 days before filing doesn’t mean the creditor will have to give it back.
Bankruptcy law provides some defenses for the preference recipient. The plain old cost/benefit analysis shields others.
The law says that a “contemporaneous exchange” isn’t a preference. So, if you fill up your car with gas, or buy new shoes, those are contemporaneous exchanges: the goods and the payment for the goods change hands at the same time.
Therefore, no preference.
“Ordinary course of business” is another widely available defense to a preference law suit. If the payment on an existing debt is standard in the industry or in the business of the debtor or the entity that received the money, it’s not a preference.
The other reality about the trustee’s right to avoid preferential payments is that small preferences are seldom pursued by Chapter 7 trustees.
By statute, payments that total more than $600 in the 90 days before filing are avoidable. But it is not economic to sue creditors to recover $600.
Each trustee has her own rule of thumb about when a preference can be effectively recovered to provide a dividend to creditors, but almost assuredly, the sum is well more than $600.
Debtors needn’t care about preferences
The 90 day rule doesn’t penalize the debtor; it puts a creditor who gets paid at some risk.
Bankruptcy law has a presumption that debts for the purchases of luxury goods of more than $800 within 90 days, and cash advances of more than $1100 within 70 days of filing are non-dischargeable. But the creditor has to file an adversary to get that determination.
Sometimes, preference recoveries by the trustee benefit the debtor when the trustee can claw back money levied or a lien perfected in the 90 day period. That money may then be available to pay priority taxes or delinquent support, creditors who hold claims that won’t be discharged without payment.
Remember too that this is a bankruptcy-specific statute. California state law is explicit that a debtor may pick and choose among his creditors, paying some and not paying others.
When preferences matter to the filer
The bankruptcy provision that does matter to debtors is the portion of Section 547 that allows the trustee to recover from the debtor’s family members payments made on debts owed to family in the year before filing.
Bankruptcy law expands the recovery period so that “insiders”, which includes partners, corporations owned or controlled by the debtor, and spouses, don’t get a disproportionate share of the debtor’s assets.
The grounds for recovery is not that the debtor did something wrong or a claim that the debt was a fraud. It’s simply an attempt to enforce fairness in the return to creditors.
If you are planning to file bankruptcy, make sure you tell your attorney about debts to those near and dear that you’ve paid in the past year.
For more about filing bankruptcy
Image courtesy of C.K.Hartman