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Priority of Claims in Bankruptcy
Filing for bankruptcy is often seen as a last resort for most people. The purpose of filing is to achieve a “fresh start” for the debtor, allowing them to pay back parts of their debt over the course of a plan, as in a chapter 13, or wipe the debt clean as in a chapter 7. While it may not be for everyone, it can be life changing for those that seek relief.
For a debtor, it is important for them to understand exactly how the court will treat the claims against them. On the other hand, it is also important for a creditor to know what to expect from the claim they hold against a debtor. Here, we will discuss what it means to hold a claim against the debtor, and how those claims will be paid in the bankruptcy case.
TYPES OF CLAIMS
To understand how a claim will be treated, the party must first determine what type of claim it is. In bankruptcy, there are three main types of claims: secured claims, unsecured claims, and priority claims. Determining what type of claim the creditor holds is crucial in determining how the claim can be treated in the bankruptcy. Regardless of the type of claim, it is important for a creditor to file a proof of claim, so the debtor and trustee can determine the best course of action for the claim and its repayment.
Secured Claims
A secured claim is exactly what it sounds like, a claim secured by some property. This commonly includes mortgages, car loans, and unpaid real estate taxes. These claims are normally evidenced by some sort of agreement, such as a promissory note. If the debtor were not in bankruptcy and protected by the automatic stay, the creditor would be able to foreclose on the secured property.
In a bankruptcy, a debtor must make post-petition payments to the debtor. This means, for example, a debtor in chapter 13 must continue to make their regular monthly payments to the company that holds their mortgage. The arrears may be cured over the course of the plan, but the debtor must show their regular monthly income can cover their regular monthly expenses.
Filing for bankruptcy does not immediately get rid of the liens against a debtor’s property. In fact, the creditor may obtain relief from the automatic stay if the debtor fails to make post-petition payments, and seek recovery through the collateral securing their claim.
Unsecured Claims
An unsecured claim is a claim a creditor has not secured by anything. Common types of unsecured claims often include credit card debt, personal loans, and medical debt. These debts are generally dischargeable in any chapter of bankruptcy, with some caveats.
Student loans are also considered unsecured claims. However, a debtor must show there exists an “undue hardship” which prevents the debtor from repaying their loans. This is a very difficult standard for most debtors to meet, and without meeting it, there will be no discharge of student loan debt.
Priority Claims
A priority claim is specific types of claims that are not dischargeable in bankruptcy. Examples of these include certain tax obligations, child support and alimony, and liabilities imposed on the debtor for reckless or dangerous behavior such as drunk driving. Priority creditors, as the name implies, take priority over other creditors and are paid first from the bankruptcy estate.
These debts are not dischargeable in any type of bankruptcy, and need to be paid for a plan to be successful. In a chapter 7, these debts will stick around even after discharge. In a chapter 13, these debts will be paid in full over the course of the plan, with any remaining priority claims also outlasting discharge.
Also included in priority claims are administrative expenses. This includes fees for attorneys, fees to the United States Trustees office, and even operating costs for a debtor in a chapter 11 case.
PAYMENT OF CLAIMS
The purpose of prioritizing claims in bankruptcy is to determine the order in which the claims are paid. Certain claims, such as administrative claims, need to be paid in full. Whereas others, such as unsecured claims, often are forced to take pennies on the dollar for the amount of money the creditor is actually owed.
Generally, the priority of claims tends to be secured claims, unsecured priority claims, and then general unsecured claims. As always, this is dependent on certain circumstances within the case.
A secured creditor’s interest is guaranteed by collateral or a lien on property owned by the debtor. Secured creditors must receive payment in association with the value of the collateral from the available funds of the bankruptcy estate. Secured claims can be overvalued, meaning the collateral is worth more than the debt, or undersecured, meaning the debt is worth more than the collateral. In a bankruptcy, when a claim is undersecured, the creditor will have a secured claim up to the value of the collateral, but an unsecured claim for anything above that value.
Next are priority claims. These claims are usually unsecured by property owned by the debtor, but still need to be paid out. These typically carry priority for public policy reasons. A bankruptcy will not wipe away this debt if it is not paid in full during the bankruptcy. However, Congress recognized that the debtor will have much fewer assets after the conclusion of the bankruptcy. Therefore, before any other unsecured creditors are paid, priority claims are paid out. Even within priority claims there is an order of payment. First, domestic support obligations, then administrative expenses, then priority tax claims.
Finally, general unsecured claims are paid last. Because these claims are not given any special priorities under the law, they have the lowest priority in the payment scheme. These creditors tend to receive a pro rata distribution of any remaining funds of the debtor. In a chapter 11 or chapter 13, unsecured claims are paid out over time, usually using monthly disposable income. In a chapter 7, unsecured claims are generally discharged if the debtor has no assets for distribution. These debts are generally dischargeable.
CONCLUSION
Whether you are a potential debtor trying to determine what your creditors will receive in bankruptcy, or a creditor forced to take an amount lower than your actual claim, you will want an experienced bankruptcy attorney to provide you guidance throughout the process. The attorneys at Scura, Wigfield, Heyer, Stevens & Cammarota LLP can help. Please call our offices to schedule a free consultation and hear your options.
Aiden Murphy, Esq.
Aiden Murphy, Esq. is an attorney at Scura Law, driven by a passion for helping others and has garnered a wide variety of experience, from estate planning and contract litigation to criminal defense and bankruptcy.
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