What Is an Antecedent Debt?
An antecedent debt occurs when a buyer owes money for one transaction and then conducts a second transaction with that lender. For example, a person may borrow $500 from his neighbor and then purchase the neighbor's house -- the $500 is called the antecedent debt. Although the purchase price of the house may include the repayment of the antecedent debt, the regulations that affect each exchange may differ.
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Debtor Rules
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It is illegal for a person to pay off an antecedent debt in a new transaction when he is insolvent and knows that he can't afford to pay off his other creditors. The creditor still has the right to collect on the debt, but other creditors also have a claim on the assets, so the creditor might not receive the full value of the antecedent loan if other creditors have priority, as stipulated in bankruptcy agreements, for example.
Creditor Rules
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The creditor may also commit fraud if it accepts payment for an antecedent debt. If the creditor knows that the borrower is insolvent when the borrower agrees to the second transaction, and the creditor is considered an insider, the creditor commits a fraudulent transfer. For example, a restaurant in a shopping mall may owe $50,000 to its food wholesaler and $100,000 to the mall for rent. If the food wholesaler accepts $50,000 for payment of the food bill, and it knows that the restaurant is insolvent but the mall doesn't, the food wholesaler would be defrauding the mall.
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Business Sale
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Repayment of an antecedent debt during bankruptcy is legal when it involves the sale of the business. If a company buys raw materials from a supplier on credit, and the supplier enters the bankruptcy process, the buyer may offer to purchase the supplier. The buyer subtracts its debt from the purchase price, so it pays less to purchase the supplier than the supplier's actual value. The buyer assumes responsibility for paying the antecedent debts of the bankrupt business when it purchases it, so the transaction does not defraud the government or other creditors.
Similar Value
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To avoid illegal fraud, any transactions must involve an exchange of assets with similar values when a person owes antecedent debts. For example, if a taxpayer sells her house to her friend for $1 because she plans to declare bankruptcy, while she owes the Internal Revenue Service $2,000 in delinquent taxes, the Internal Revenue Service can still make a claim on the house because the sale wasn't at a reasonable market valuation.
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