Preferential transfers to insiders
Under 11 U.S.C. § 547, the trustee can avoid (claw back) payments made to creditors before filing if those payments give the creditor more than they would receive in a Chapter 7 liquidation. For ordinary creditors, the lookback is 90 days. For insiders -- family members, business partners, and closely related entities -- the lookback is 1 full year.
Family members are insiders under § 101(31). If you paid your mother back $5,000 on a personal loan 8 months before filing, the trustee can sue your mother to recover that $5,000 for the estate.
11 U.S.C. § 547(b): The trustee may avoid any transfer of an interest of the debtor in property to or for the benefit of a creditor, made within 90 days before filing (or 1 year for insiders), if the creditor received more than they would have in a Chapter 7 liquidation.
Why this happens
People feel obligated to pay back family before filing. They think: "I owe my brother $10,000. He loaned it to me in good faith. I should pay him back before I file." The intention is honorable, but the legal consequence is that you have dragged your brother into your bankruptcy case.
The trustee does not care about your intentions. The trustee sees that one creditor got paid while others got nothing. That is the definition of a preference -- and the Code requires the trustee to pursue it.
What happens to your family member
- The trustee sends a demand letter to your family member requesting return of the payment
- If they do not pay voluntarily, the trustee files a lawsuit (adversary proceeding)
- The court can order your family member to repay the money to the estate
- Your family member may need to hire their own attorney to respond
The 1-year lookback for insiders is one of the longest in the Code. Even payments made 11 months before filing can be recovered. If you are considering bankruptcy, stop making payments to family members immediately and consult an attorney.
The good news: your family member may still get paid. Once the preferential payment is returned to the estate, your family member becomes a creditor in the bankruptcy case and may receive a distribution -- just like every other unsecured creditor.