How Are Debts Prioritized in a Bankruptcy Case?

 Posted on September 10, 2021 in Bankruptcy

Creditors will often need to address situations where debtors do not pay the debts they owe. While creditors can often take action to recover what is owed through debt collection practices, they may be concerned about their ability to collect debts when a debtor files for bankruptcy. In these cases, creditors will need to understand how different types of debts are prioritized and when they may be able to recover what is owed.

Bankruptcy and Priority of Claims

A creditor’s ability to recover debts during a bankruptcy case will depend on their type of claim and whether the debtor is filing for Chapter 7 or Chapter 13 bankruptcy. When a debtor files for Chapter 7, the bankruptcy trustee will liquidate their non-exempt assets, and the proceeds will be distributed among the creditors. When a debtor files for Chapter 13, they will submit a proposed repayment that will last for a period of three to five years, and these payments will be distributed among the creditors whose debts are included in the plan.

Debts are repaid to creditors in the following order:

1. Priority unsecured claims - A debtor’s domestic support obligations will be given the highest priority. If the debtor owes child support or spousal support, the amount that is past due must be repaid in full before any other debts can be repaid. Other priority claims include the administrative costs of bankruptcy that are paid to the trustee and most types of tax debts.

2. Secured claims - Creditors who hold liens on property held by a debtor will be repaid first after priority unsecured claims. In a Chapter 7 bankruptcy case, the creditor may repossess the collateral, or the debtor may reaffirm the debt and continue making payments. If the value of the property that is repossessed is less than the amount owed, the creditor may have an unsecured claim for the remaining amount owed. In a Chapter 13 bankruptcy case, a debtor may keep the property in a secured debt and continue making payments, and past-due amounts may be repaid through their repayment plan. Secured debts that are included in a bankruptcy case must generally be paid in full before other debts can be repaid.

3. General unsecured claims - Any debts that are not secured by a lien will have the lowest priority. These include credit card debts and medical bills. In some cases, a junior loan such as a second mortgage may be “stripped off” and reclassified as an unsecured debt. After other debts have been repaid following the liquidation of property in a Chapter 7 bankruptcy or through a repayment plan in a Chapter 13 bankruptcy, the remaining amount will be divided among creditors with unsecured claims.

Contact Our Chicago Bankruptcy Attorneys for Creditor Representation

At Dimand Walinski Law Offices, P.C., we provide representation for creditors during bankruptcy proceedings or when collecting debts. To learn how we can help you recover what is owed to you, contact our Chicago, IL creditors’ rights lawyers at 312-704-0771.

Sources:

https://www.law.cornell.edu/uscode/text/11/507

https://www.kirkland.com/sitefiles/kirkexp/publications/2392/document1/friedland_priorities.pdf