Personal Loan to a Friend and Bankruptcy
Can your friend (assuming he is your friend after this) wipe out the personal loan you gave them if they file for bankruptcy? Let’s dig deeper into this issue and find out what steps you should take to protect yourself if you loan money to a friend or family member who is now considered a debtor. Issues with the bankruptcy trustee will also be discussed.
Listen to this podcast.
Key Points:
- The law treats all unsecured debt the same, regardless of whether money is owed to a bank or a friend.
- Getting paid back your personal loan could result in getting sued by the bankruptcy trustee.
- Even though you loaned money to a friend or family member, you can seek collateral to secure your loan, and there should be a written agreement.
Helping Out Your Friend or Family Member with a Personal Loan
I’ve always been fond of the saying that the road to hell is paved with good intentions. My second favorite quote is that no good deed goes unpunished. But chances are we have all been there whether we need to borrow money or someone is asking to borrow money from us.
For example, I borrowed $20,000 from my father when I started my law practice. And yes, I paid it all back promptly. I even needed to borrow money to take the bar review courses while preparing for the Florida bar exam.
But what happens when you loan money to a friend or family member and they file for bankruptcy? Can bankruptcy wipe out that debt?
Personal Loans and Bankruptcy
There are two types of personal loans. A personal loan can be unsecured, which means it is not attached to any collateral, or it can be secured. Unsecured personal loans can be an excellent way to consolidate debt or resolve an emergency. I even wrote a blog post on how I used a secured personal loan to improve my credit after foreclosure. You can read that blog post below.
I still use personal loans. I’ve written before about how I qualified for a personal loan to get funding for my steel garage. Once I pay off that personal loan, I will likely get another one to pay off my IRS debt.
While I know I will pay interest on that debt, I’m already paying the IRS interest. However, my monthly payments to the IRS have no effect on my credit because they are paid straight out of my checking account. With a personal loan, I can wipe out the IRS tax debt, and now the debt will appear on my credit report, and at least I get some benefit out of it credit-wise.
Like any other unsecured debt, a personal loan can be wiped out in bankruptcy. But can a personal loan be wiped out if the loan is between friends or family?
Debtor and Creditor Law
Debtor and creditor law, for the most part, is straightforward. For example, I once wrote a blog post about the musical artist Cardi B and how she became a creditor based on a defamation of character lawsuit. Because she won the lawsuit, and now money was owed to her as a judgment, she is a creditor in the eyes of the law.
In that example, Cardi B is no different than any other creditor, whether it be Chase Bank or your MasterCard. That blog post can be seen below.
That means that even if you loan money to a friend or family member, under debtor and creditor law, you are a creditor. It might be a friend or a family member, but your rights are not superior to that of traditional creditors. This could present a problem if you loan money to a friend or family member and they file for bankruptcy.
Can My Personal Loan to a Friend or Family Member Be Wiped Out in Bankruptcy?
The short answer to whether a personal loan to a friend or family member can be wiped out in bankruptcy is yes. You are a creditor in bankruptcy law. No more, no less. Will Thanksgiving be awkward? Yes. But the law does not account for awkwardness.
Should I Get Paid Back the Personal Loan Before Bankruptcy is Filed?
Because a personal loan to a friend or family member is no different than any other unsecured debt, there are limits to paying back that debt before filing for bankruptcy.
While each case is different, generally speaking, a debtor should not use credit cards or make unsecured debt payments approximately 60 to 90 days before filing for bankruptcy.
However, paying back a credit card company versus paying back a personal loan to a friend or family is likely to be treated differently by the bankruptcy trustee.
For example, if a payment was made to a credit card company for $1,000, it is unlikely the trustee will go through the trouble of suing the credit card company to claw back those funds. Even though the trustee has the authority to do so, it is not likely.
However, the same situation happens when a family member is paid back. In that case, you are guaranteed that the trustee will ask the debtor to pay back those funds or file a lawsuit against the family member who received the payment.
The Bankruptcy Petition
In the bankruptcy petition, a section called Statement of Financial Affairs asks about payments recently made to creditors and if payments have been made to “insiders.” By insiders, that refers to payments or transfers made to friends and family.
When assets or payments are made to insiders, it is common for the trustee to pursue those funds and, if need be, file a lawsuit against the person who received the funds. So, there should be payments or transfers to insiders if the situation has been fully explained to your bankruptcy lawyer.
Protecting Your Personal Loan
Now that you understand there is that risk that your debt can be eliminated in bankruptcy, and if payments are made to you directly near the filing date, what can you do to protect yourself if you give a personal loan to a friend or family member?
Like any creditor, you have the right to secure that loan with collateral. However, even though we are amongst friends and family, the terms of that agreement should be spelled out in writing to ensure clarity.
It should also be noted that just because the loan is secured doesn’t mean the trustee will not inquire further into this situation to confirm there are no fraud issues.
Colleges and universities can purchase my bankruptcy law textbook directly from Routledge Publishing. For paralegals and students buying single copies, you can do so via Amazon Books. To access my YouTube channel, click this link.
Please note that the information on this site does not constitute legal advice and should be considered for informational purposes only.
Need to look for prior blog posts or other categories? Click the links below:
Please note that the information on this site does not constitute legal advice and should be considered for informational purposes only.
Discover more from Bankruptcy.Blog
Subscribe to get the latest posts sent to your email.