The Congress has deemed certain debts as being so important that they must be paid in full and cannot be wiped out in a bankruptcy. These types of debts are called priority debts or claims.
Classification of Debts Under the Bankruptcy Code
Generally speaking, the Bankruptcy Code classifies debts under one three categories: (1) secured debts; (2) priority unsecured debts; and (3) non-priority/general unsecured debts.
Secured debts are debts in which the creditor has a lien against the debtor’s property. The typical example of secured debts are debts such as mortgages and auto loans where the creditor and the debtor agreed that the creditor should have a lien against the home or car as a condition for the debtor obtaining financing from the creditor to purchase the underlying asset. The lien allows a creditor to seize the property purchased by the debtor in case the debtor’s defaults on the debt. The creditor then sells the property to recoup some or all of what they are owed. Although home mortgage and auto liens are consensual, non-consensual liens also exist and are considered secured debts. Examples of non-consensual liens include IRS tax liens, HOA liens, and property tax liens.
If the property at issue is either liquidated or surrendered in a bankruptcy, any balances owed to the creditor after the lienholder sells the property becomes a general unsecured non-priority claim. For example, if a home is worth $500,000, but owes $540,000 on its mortgage, the $40,000 deficiency would become a general unsecured non-priority claim which could be eliminated in a bankruptcy.
Priority Unsecured Claims
Debts not secured by a lien are considered unsecured. Some unsecured debts have been deemed so important by policymakers that they cannot be eliminated in a bankruptcy. They must either be paid in full during the life of a Chapter 13 bankruptcy case or they must be paid after the conclusion of a Chapter 7 case.
Examples of priority unsecured claims include but are not limited to: (1) domestic support obligations, (2) some wages and salaries owed to employees, (3) various taxes, and (4) claims for wrongful death or personal injury result from the debtor’s driving while intoxicated.
General/Non-priority Unsecured Claims
Non-priority unsecured claims include credit card, medical and attorney bills. These types of non-priority debts can be eliminated in a bankruptcy if the debtor does not have enough non-exempt assets that can be used to pay some or all of what these types of creditors are owed. In fact, in most bankruptcies these types of creditors get nothing or just pennies on every dollar they are owed.
In many instances, debtors who have a lot of priority debts are well served by a Chapter 13 bankruptcy. Because a Chapter 13 bankruptcy lasts anywhere from 3-5 years, the debtor can stretch the payments of these debts during that time period.
Similarly, if a debtor has a lot of non-priority unsecured debts such as credit card bills, and if eliminating these types of debt would allow the debtor to pay his priority debts on-time, Chapter 7 might be a good option.
Bottom line: If you have questions about the types of debt you have and how they will be treated in bankruptcy, feel free to give our office a call. Initial consultations are always free.