Understanding Secured, Unsecured & Priority Claims in Bankruptcy
Find out what secured, unsecured, and priority debt are, and how they are treated in bankruptcy.
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When you file bankruptcy, each creditor (the person or company to which you owe money) has a claim against your bankruptcy estate. This means that if there's any money in your estate, the bankruptcy trustee will use it to pay the creditors' claims. To get paid, each creditor must file a proof of claim form indicating how much you owe and the type of debt. There are three main categories of debts in a personal bankruptcy case: priority unsecured debt, secured debt, and general unsecured debt.
For more information about payment of bankruptcy claims, see What Happens to Your Debt in Bankruptcy?
Priority Unsecured Claims
Priority unsecured claims are claims that are not secured by collateral but that have priority over other debts under federal law. These debts have priority typically for public policy reasons -- that is, the well-being of the public depends upon these debts being paid. Priority unsecured debts in a personal bankruptcy case might include child support, spousal support, and any other domestic support obligations; certain income taxes; and any amount you owe if you caused the death or serious injury of another person because you were driving while intoxicated.
Priority unsecured debts are non-dischargeable, which means that any amounts that do not get paid in your bankruptcy are still outstanding. The bankruptcy does not wipe out your obligation on priority unsecured debts unless they are paid in full through the case.
General Unsecured Claims
General unsecured claims are claims that have no priority and are not backed by a security interest in property. General unsecured debts include credit card debts, student loans, personal loans, some utilities and medical bills. General unsecured claims have the lowest priority of all claims. After the bankruptcy estate pays administrative expenses, priority unsecured claims and secured claims, general unsecured creditors will receive a pro rata distribution of the remaining funds.
General unsecured debts are generally dischargeable, which means any amount that is not paid through the bankruptcy is wiped out and no longer your responsibility. There are exceptions to this rule; student loan debt is only dischargeable if you can demonstrate extreme hardship. Also, if you obtained a debt fraudulently, the creditor can ask the court to deem it nondischargeable. For more information about nondischargeable debts, see Bankruptcy Discharge: Which Debts Are Wiped Out?
Example. Anne files Chapter 13 bankruptcy. She owes the IRS $10,000, which is a priority unsecured claim. She also owes $100,000 in general unsecured claims. Over the course of Anne's Chapter 13, she will make $55,000 in Chapter 13 plan payments. Of those payments, $8,000 will go toward administrative expenses, such as trustee fees and attorney fees. The IRS will receive $15,000 for the tax debt plus interest. The remaining $32,000 will be distributed pro rata to the general unsecured creditors. $32,000 is 32% of the total $100,000 debt, so each general unsecured creditor will receive 32% of the amount owed, and the rest will be discharged.
Example. Ben files Chapter 7 bankruptcy. He owes back child support in the amount of $12,000. He also owes $25,000 in credit card debt. He owns an RV that he cannot exempt, so the trustee sells the RV for $10,000. The trustee's expenses, including fees, for the sale of the RV total $1,500. The remaining $8,500 of the proceeds will be paid to the state for the child support arrears; the credit card companies will receive nothing, and the credit card debt will be discharged. Ben will still be responsible for the remaining $3,500 in back child support.
Example. Kyle was sued by the family of a man he killed in a drunk driving accident. The court awarded the family $500,000 in wrongful death damages, and Kyle is responsible for the full amount. He also owes $25,000 in credit card debt. Kyle is unemployed, so he files Chapter 7 bankruptcy. His estate has no assets, so none of Kyle's creditors will receive payment. The credit card debt will be discharged; however, Kyle will still be responsible for the $500,000 wrongful death judgment.
Secured claims are claims for debts that are secured by an interest in property. A secured creditor can take that property, the collateral, if you default on the debt. The most common secured loans are car loans and mortgage loans, but you may also have secured loans for furniture, jewelry, watercraft, and other types of property.
In a bankruptcy case, secured claims must be paid in full if you want to keep the property that secures the loan. If you choose to surrender the property (give it up), the loan is treated as a general unsecured debt.
Example. Dave owes $10,000 on his car; the car is worth $8,000. Dave files Chapter 7 bankruptcy; his estate has no assets. He cannot afford the car, so he chooses to surrender it. The dealership repossesses the vehicle and sells it for $4,000. The remaining $6,000 of the loan is discharged in Dave's bankruptcy.
Example. Sue files Chapter 13 bankruptcy to save her car. Her Chapter 13 plan proposes to pay the full balance of the loan, which is $8,000, plus interest. Two years into her Chapter 13 case, Sue suffers a pay cut at work and can no longer afford the car. She modifies her Chapter 13 plan to surrender the car. The current balance due is $5,000. The creditor repossesses the car and sells it for $2,000. The creditor must then amend its proof of claim with the bankruptcy court to reflect a general unsecured claim in the amount of $3,000, which will be paid pro rata along with all other general unsecured creditors.
Example. Joanne is underwater on her house; she owes $150,000 to the mortgage company, but her latest tax appraisal gives a value of $100,000. She has fallen behind on her mortgage payments. She files Chapter 7 bankruptcy and decides to surrender the house. She does have an investment account that she cannot fully exempt, and the trustee seizes $8,000 from the account. The mortgage company forecloses and sells the home for $60,000, leaving a deficiency of $90,000. The mortgage was Joanne's only debt. The trustee's fees for the seizure of the investment account total around $1,500, leaving $6,500 for creditors. The mortgage company receives the $6,500 and the remaining $83,500 deficiency balance is discharged.