What is the 90-day rule for Chapter 7 bankruptcy?

Personal bankruptcy inquiries have been surging recently as borrowers try to grapple with an influx of economic issues, including persistent inflation and high borrowing rates. And, the interest in Chapter 7 filings, in particular, reflects the mounting financial pressure many borrowers are feeling as they carry record levels of debt. Known as liquidation bankruptcy, Chapter 7 allows borrowers to wipe the slate clean in terms of unsecured debts, which can provide a fresh start for those drowning in credit card bills and medical expenses — but the path to relief comes with strict rules that can catch filers off guard.

One of these rules, known as the "90-day rule," can have a big impact on what happens to the payments you've recently made to creditors. Under this rule, you might be in for an unwelcome surprise if you've been strategically paying down certain debts before considering bankruptcy, like settling your car loan to keep your vehicle or paying back money you borrowed from family. That's because the bankruptcy court doesn't just look at your current financial snapshot; it also scrutinizes your recent financial behavior.

With this rule in place, what may otherwise seem like responsible financial management can create complications that have a big impact on your case. So, what exactly is the 90-day rule for Chapter 7, and how can it impact the bankruptcy process? 

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What is the 90-day rule for Chapter 7 bankruptcy?

The 90-day rule in Chapter 7 bankruptcy refers to the "preference period," which is a window of time in which the bankruptcy trustee can review and potentially reverse certain payments or transfers you made to creditors. Under this rule, any payment of $600 or more made to a creditor within 90 days before filing your bankruptcy petition may be considered a "preferential transfer."

Here's how it works: When you file for Chapter 7, you're essentially asking the court to discharge your debts after liquidating your non-exempt assets. The bankruptcy trustee's job during this process is to ensure that all creditors are treated fairly under bankruptcy law. That means if you paid one creditor more than others would receive in bankruptcy during those 90 days, the trustee can demand that money back and then redistribute it equally among all your creditors.

For example, if you paid off your $3,000 credit card balance two months before filing bankruptcy, the trustee could sue that credit card company to recover the $3,000 payment. The money would then go into the bankruptcy estate to be distributed proportionally among all your creditors. The same applies to payments on loans, medical bills or other debts.

There's an important exception, though: Ordinary course payments don't count as preferences. If you were making regular monthly payments on a debt according to the borrowing terms, for instance, those typically won't be reversed. It's the unusual payments, like large lump sums, accelerated payoffs or settling debts for less than you owe, that can trigger scrutiny.

That preference period also extends to one year for "insiders," which includes family members, business partners or close friends. So, if you repaid $2,000 to your parents six months before filing, the trustee could recover that money even though it falls outside the standard 90-day window.

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Why does the 90-day rule matter to borrowers?

Understanding the 90-day rule is crucial for anyone considering their debt relief options, whether they plan to tackle their debt through bankruptcy or the alternative strategies available to them. So, if you're exploring ways to manage your overwhelming debt, the timing becomes a strategic consideration that can significantly impact your outcome.

That's because many borrowers who are contemplating bankruptcy will make the mistake of trying to clean up their finances before filing by paying off certain debts they want to protect. This often backfires, though. Not only can those payments be reversed by the trustee, but the legal process of recovering preferential transfers can add months to your bankruptcy case and increase your legal costs. 

For those weighing bankruptcy against other debt relief strategies, the preference period highlights why professional guidance matters, both when determining the appropriate strategy and as you actually work your way through the process. For example, debt relief programs that negotiate settlements with creditors operate differently from bankruptcy and aren't subject to the same clawback rules. So, if you settle a credit card debt for 50% of what you owe through a debt relief company, that payment won't be reversed later, though you should understand the tax implications and credit impact of settlement programs.

The rule also affects the timing of your decisions. If you've recently made substantial payments to creditors, waiting until those payments fall outside the 90-day window before filing bankruptcy might be the most strategic approach. However, you should consult with a bankruptcy attorney or debt expert about whether waiting makes sense given your specific circumstances and the risk of creditor lawsuits during the delay.

The bottom line

The 90-day preference rule exists to ensure fairness in bankruptcy. While this serves an important purpose in bankruptcy law, it can create unintended consequences for borrowers who simply tried to pay their bills before filing. So, before making any large debt payments or filing for bankruptcy, it typically makes sense to consult with a debt expert who can review your recent financial transactions and help you navigate these timing rules. And, be sure to explore all available debt relief options, too, to ensure that you choose the path that allows you to protect your interests and find a way to financial recovery.