Why pay off a credit card or other debts before you file bankruptcy?

This would seem to be a counter-intuitive thing to do.  After all, you’re filing bankruptcy presumably because you need to eliminate debts.

But many debtors choose to pay off some of their creditors right before filing bankruptcy.

Many think that by paying off a credit card before filing bankruptcy, they will continue to be able to use that card after bankruptcy and that it will not be “included” in their bankruptcy case.

That is wrong, and here’s why.

Paying Off Credit Cards Does Not Allow You To Keep Them

Most credit card companies will close your account upon filing a bankruptcy case, regardless of whether you list them or owe them money.

While it might seem to make sense that if you don’t owe money to a credit card company when you file bankruptcy they’d be more likely to leave your account open, it simply isn’t the case.

In fact, the opposite is true.

You have a better chance of keeping your account open if you owe them money, because then if you agree to repay it to them (through a reaffirmation agreement), they have an incentive to continue to extend you credit.

I am not at all recommending one actually DO that, but rather I’m pointing out how the credit card companies “think”.   See why reaffirming debts in bankruptcy is usually a bad idea.

But there’s an even bigger reason not to pay off your creditors significant amounts prior to filing bankruptcy…

Repaying Any Debts Prior To Bankruptcy Can Result In Some Debts Not Being Discharged

This is the part most don’t think about.   Here’s what can happen in a Chapter 7 case.

If you repay more than $600 to any creditor within 90 days prior to filing your bankruptcy case, the bankruptcy trustee (in a Chapter 7 or 11 case) can sue the creditor to recover what you repaid to them.

Your payment is called a “preferential” payment and The Bankruptcy Code allows such recovery by the Trustee on behalf of all creditors.

Repayments made to family members and other “insiders” within one year prior to filing can also be recovered.

Usually people filing bankruptcy care if their parents or favorite uncle are going to be sued by their bankruptcy trustee to recover money they repaid to them.

But why would they care whether Citibank or Wells Fargo get sued for being repaid?

In other words, what does repaying these debts have to do with discharging your other debts?

The Asset vs. No-Asset Chapter 7 Case

In a typical Chapter 7 case, no assets are liquidated and disbursed by the Trustee.  These are called “no asset cases”.

In a No-Asset Chapter 7 case in the 9th Circuit, and in many other parts of the country, you get discharged from all dischargeable debts regardless of whether or not the creditor was listed or received notice of the bankruptcy case.¹  This comes from the famous (among bankruptcy attorneys) Beezley case decision.

This is not an insignificant thing.  Many people who file bankruptcy don’t know all their creditors because they are not as organized as one might hope to be, or creditors have sold their accounts to others, etc.

So, if the Trustee in your bankruptcy case recovers a bunch of preferential payments from those you’ve repaid in that 90 (or 1 year) period and then distributes that recovery to the creditors, this is no longer a “No Asset” case and it suddenly becomes very important to make sure you have accurately listed all people and entities to whom you owe, or may owe, money.

It has now become an Asset Case and debts of creditors who were not listed, or listed with an incorrect address, may not be discharged and you may end up having to pay them after your bankruptcy case is completed.

That is a pretty strong unintended consequence of repaying your debts.

Sometimes Repaying Debts Is Helpful

I sometimes advise my clients to continue paying on their credit cards (but always to STOP using them) as part of my pre-bankruptcy filing strategy.

The reason for this is to make it less likely the creditors will object to the discharge of a specific debt because there was a lot of recent charges.

It’s very fact-specific and not something I advise in all cases and when I do, it is with restrictions and careful instructions.

This is yet one more reason that hiring a qualified bankruptcy attorney can prevent problems.


¹ Creditors in No-Asset cases who did not receive timely notice of the bankruptcy filing can still seek to reopen the bankruptcy case to object to the discharge if they have a basis to do so, such as fraud.

Image Courtesy of Chris Potter