Most bankruptcy filings result in a lack of sufficient funds to pay off all creditors in full, leaving some creditors with the potential of not receiving some or even all of what is owed to them. The bankruptcy code also gives preference to some claims over others, further complicating this issue. Secured creditors are generally paid first, and then the law applies a system of priority to distinguish the different types of unsecured creditors.
Under the priority system, certain unsecured creditors are entitled to full payment before other unsecured creditors receive anything at all. Whether a creditor filed a proof of claim form within the deadline also influences the order of payment. Anyone owed money in a bankruptcy should contact an attorney as soon as possible to not only find out about all the options available to them but to make sure they receive the highest amount of what they are owed.
The Priority Order
Below is the order of priority in all bankruptcies. It’s important to note that not every case will have claims at every level. Indeed, it’s not possible to have claims at every level because some claims can only be incurred by individuals and others can be incurred only by businesses. What claims exist depend on the debtor’s situation.
- Domestic support obligations, such as alimony, maintenance, or child support
- Bankruptcy administration expenses
- Certain claims arising after creditors file a lawsuit to force debtor into involuntary bankruptcy
- Wages of a debtor’s employee earned within 180 days before filing of bankruptcy and up to $13,650 per claimant
- Unpaid contributions to the debtor’s employees’ retirement plans up to $13,650
- Certain claims by farmers and fishermen
- Security deposits for the purchase, lease, or rental of property or services
- Certain unpaid taxes
- Unpaid deposits to banking regulatory agencies (only applicable if the debtor is a bank)
- Claims for death or personal injury caused by the debtor’s drunk driving
Any claim that does not fit into one of these categories is not considered priority, and will only be paid if there is money left over after paying all priority claims.
Contracts and claims can come in many forms, and it’s sometimes unclear whether such a claim fits into a priority category. For example, a debt owed to an ex-spouse might be considered either a domestic support obligation (top priority) or a property settlement (not priority). In cases like this, the classification comes down to arguments made in court, so it’s crucial to have a lawyer representing your interests.
Priority in Chapter 7
In a chapter 7 proceeding, a debtor’s assets are sold and the proceeds of the sale are divided among their creditors. Secured creditors are entitled to payment up to the value of the collateral or the size of their claim (whichever is smaller) before any other creditors are paid. Anything left over is used to pay unsecured creditors.
There is almost never enough to pay all unsecured creditors in full. This makes sense. If the debtor could pay their debts they most likely would not be eligible for Chapter 7, and they would either be filing for Chapter 13 bankruptcy or not filing at all.
The order of payment to unsecured creditors is determined by priority and whether the proof of claim was filed before the deadline. Timely claims are paid before late claims, and priority claims are paid before non-priority claims.
Unsecured claims either fall into one of the ten priority categories or they are considered non-priority. When paying claims, the bankruptcy court starts with the highest priority and works through each level of priority before paying non-priority claims. All claims at a priority level must be paid in full before any claims at the next priority level are paid.
If there is not enough money to pay all the claims at a priority level, the money is split between them on a pro-rata basis. This means that the claims are paid in proportion to how large they are. For example, if the debtor’s estate has $2,000 available to pay a $3,000 claim and a $1,000 claim at the same level of priority, $1,500 goes toward the first claim and $500 goes toward the second claim. Any claims below this level of priority would not receive any payment at all.
Priority in Chapter 13
Priority provides even more protection to unsecured creditors in a chapter 13 proceeding. In chapter 13, a debtor pays debts with future income, not present assets. A chapter 13 case requires a debtor to pay his or her disposable income to creditors over the course of three to five years. However, if a debtor’s disposable income is very low (as is often the case with people who file for bankruptcy), unsecured creditors can end up with almost nothing.
However, priority unsecured creditors are entitled to be paid the full value of their claim at the time of filing over the course of the plan, though they are not entitled to interest on that claim. For example, if the debtor owes $10,000 in wages to a creditor at the time of the filing, the creditor is entitled to $10,000 in payment divided up over the course of the plan. A court will not allow a debtor to file a chapter 13 repayment plan that does not pay all priority claims in full.
This full payment requirement also means that priority creditors are not in competition with each other like they are in chapter 7. All priority claims, whether first priority or tenth priority, are entitled to full payment.
It’s important to note that full payment of priority unsecured creditors may mean dramatically less payment for non-priority unsecured creditors. Non-priority creditors are entitled only to whatever disposable income is left after the debtor pays secured and priority claims, which may be as low as pennies on the dollar.
Thus, it’s crucial that any unsecured creditor whose debtor files for chapter 13 contact a lawyer to see if it’s possible to receive priority on their claim. Whether a claim fits into a priority category is sometimes ambiguous, and a skilled lawyer can make the difference between priority status with full payment and non-priority status with pennies on the dollar being repaid.
Priority in Business Bankruptcy
Business bankruptcies have their own hierarchies of priority. If a business is liquidating in chapter 7, unsecured creditors receive payment in the same order of priority as they would in an individual’s chapter 7. For example, employees would be entitled to payment before the IRS, and the IRS would be entitled to payment before unsecured creditors without priority.
However, in a business chapter 7 bankruptcy, unsecured creditors as a whole have priority over shareholders and partners in the company. Thus, after priority unsecured creditors are paid, non-priority unsecured creditors like vendors must be paid in full before any shareholders receive payment. This often means that shareholders receive no payment at all.
Priority works somewhat differently in a chapter 11 reorganization. Chapter 11 bankruptcy seeks to have the creditors and shareholders of a bankrupt business come to an agreement about reorganizing the business in a way that will allow for repayment of debts. The court divides different interest holders (usually secured creditors, unsecured creditors, and shareholders) into committees. The committees have the power to disapprove a reorganization plan.
The bankruptcy court often does not create a separate committee for priority unsecured creditors, especially if their interests align with the rest of the unsecured creditors. Thus, the priority order plays less of a role in chapter 11 than it does in chapter 7 or chapter 13. This makes sense because chapter 11 is about flexibility and allowing all of the interest holders to come to an agreement among themselves.
One important form of priority exists in a chapter 11 case, called the absolute priority rule. The absolute priority rule allows a class of interest holders to veto the reorganization plan if the plan pays a junior interest. For example, unsecured creditors have a right to veto any plan that would pay shareholders. This rule forces junior interests, such as shareholders, to make sure that the plan satisfies all senior interests.
What Should I Do if Someone Who Owes Me Money Files for Bankruptcy?
If someone who owes you money files for bankruptcy, contact Rosenblum Law for a free consultation today. Bankruptcy dramatically affects your rights and can prevent you from receiving the full amount you’re owed. Our experienced bankruptcy attorneys will make sure you receive as much of what you’re owed as possible. Call 888-815-3649 or email us today.