People who are struggling with debt often take out loans from family members to help cover some of their expenses. However, if the debt load gets to be too much and they decide to file for bankruptcy, they may not know exactly how to handle loans obtained from their relatives. If you find yourself in this situation, here's some advice on what you should do.

Bankruptcy Law Requirements

When you file for chapter 7 bankruptcy, you are required to list all of your creditors on schedules D, E and F. Failure to do so can lead to, at minimum, those debts not being discharged by the court. This allows your family member to continue attempting to collect the money owed including filing a lawsuit.

Sometimes not listing a debt owed by a family member on your petition can lead to charges of bankruptcy fraud. This can occur if you make payments on the loan or transfer assets to the person in an effort to satisfy that financial obligation prior to filing bankruptcy. The trustee may think you're trying to conceal assets and initiate an investigation that may result in dismissal of your case, federal charges, being sentenced to up to 5 years in jail and/or a $250,000 fine.

Although it may make you uncomfortable to do so or lead to a troubled relationship with your family member, it's best to stay on the right side of the law and list the debt in your bankruptcy petition.

The Issue of Avoidable Preferences

One of the consequences of listing loans by relatives on your creditor schedules is they may be required to turn any payments you made to them over to the court. When you file your petition, the trustee looks at transactions that have occurred up to a certain period of time prior to the filing depending on type of creditor and transaction being investigated.

The reason for this is the bankruptcy court wants to make sure all creditors are treated equally. The money paid to any creditors shortly before the filing would be seen as showing preference to those people, and the trustee may make moves to recover that money and redistribute it in an equitable manner to all of your creditors.

Officially, creditors who receive money from the debtors prior to the filings are called "avoidable preferences", and they fall into one of two categories:

• Regular – These are standard creditors like your credit cards and mortgage lenders.
• Insiders – These are people close to you such as your relatives, friends and business associates.

The trustee treats these two groups differently. He or she will only view the transactions made to regular creditors in the 90 days prior to the filing. However, this time limit is extended to one year for insiders. In either case, the trustee can request people who've been paid $600 or more to turn that money over to the court. The same goes for any assets you may have given your family members to pay off the loan.

Options for Handling Personal Loans

As you can imagine, getting caught up in an "avoidable preference" situation can cause some problems especially if the person has already spent the money or is currently using the asset you gave him or her. This is why it's critical to speak to relatives who you owe money before you file for bankruptcy and advise them that they may be required to submit the payments you gave them to the court. This allows them to prepare for this eventuality.

If you repaid a significant amount of money—more than the person can pay back—or you paid the loan off completely, you can postpone filing for bankruptcy until the time limit expires. While this is not ideal if you're dealing with a significant amount of debt, it's the best way to ensure the trustee won't try to take back that money. It's a good idea to work with a bankruptcy attorney who may help you negotiate a repayment plan with your other creditors that will tide you over until you can officially file for chapter 7 bankruptcy.

If the "avoidable preference" is not an issue for you, there are a couple of ways you can handle debt owed to family members. You can sign a reaffirmation agreement for the loan. This will keep your legal responsibility for repaying the money intact, though, meaning your relatives can still sue you in court for the money if you fail to keep up on the payments.

Another option is to simply let the court discharge the debt and pay the money anyway after your case has been resolved. This allows you to repay your relatives while still affording you protection from any legal action the person may bring if you fall on hard times and can't pay.

For more information about filing for bankruptcy or advice on handling financial obligations to your relatives, contact a bankruptcy attorney for assistance.