Understanding Secured, Unsecured and Priority Claims in Bankruptcy

Bankruptcy law sorts your creditors into three groups—secured, priority unsecured, and general unsecured—and a creditor’s group determines whether, when, and how much it gets paid. Secured creditors get paid out of the sale of collateral, such as a house or financed car. When money is available to distribute to unsecured creditors, priority unsecured creditors, such as child support and recent tax claims, get paid first. General unsecured creditors, such as credit card companies, share whatever is left, which is often nothing in Chapter 7, and a percentage of the filer's disposable income in Chapter 13. (11 U.S.C. § 507(a); 11 U.S.C. § 726(a).)

The table below shows how each type of claim is treated in each chapter.

What Are Priority Unsecured Claims in Bankruptcy?

Priority unsecured claims are debts with no collateral behind them that the law pays ahead of other unsecured debts, typically for public policy reasons, meaning the public’s well-being depends on these debts being paid. With an unsecured debt, you haven’t agreed to put up any property as security for payment, and generally the creditor doesn’t have the right to take any of your property to satisfy the debt.

Priority unsecured debts in a personal bankruptcy case might include:

• child support
• spousal support
• other domestic support obligations
• recent income taxes
• wages that you owe your employees, and
• amounts for death or serious injury that you caused while driving intoxicated.

Priority unsecured claims have priority over general unsecured claims. They are first in line to be paid out of the bankruptcy estate in a Chapter 7 case or through your repayment plan in a Chapter 13 case.

Many priority debts, including support and most recent taxes, are nondischargeable. Any amount not paid in a Chapter 7 case remains your responsibility and won’t be eliminated in the bankruptcy. In a Chapter 13 case, all priority unsecured claims will be paid in full over three to five years as part of your Chapter 13 repayment plan. (11 U.S.C. § 507(a); 11 U.S.C. § 523(a); 11 U.S.C. § 1322(a)(2).)

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, a priority unsecured debt. Kyle is responsible for the full amount. He also owes $25,000 in credit card debt. Kyle is unemployed, so he files for 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. (11 U.S.C. § 523(a)(9).)

What Are General Unsecured Claims in Bankruptcy?

General unsecured claims are debts with no collateral and no priority, so they’re paid last, and only from whatever money is left. General unsecured debts include (although exceptions exist):

• credit card debts
• student loans
• personal loans
• some utilities, and
• medical bills.

After the trustee pays administrative expenses and priority claims, general unsecured creditors who filed timely claims share a pro rata (equal percentage) distribution of the remaining funds. (11 U.S.C. § 726(a).)

Most general unsecured debts are dischargeable, meaning any amount not paid through bankruptcy is wiped out and no longer your responsibility. There are exceptions to this rule, known as nondischargeable debts. (11 U.S.C. § 523(a)(2)(C); 11 U.S.C. § 523(a)(8).)

• Student loan debt is dischargeable only if you can demonstrate undue hardship.
• If you obtained a good or service through fraud, the court can declare the debt you incur to be nondischargeable.
• Debts you incur for luxury goods or services within 90 days before filing bankruptcy and cash advances taken within 70 days before filing bankruptcy are presumed to be nondischargeable. However, they'll be eliminated in the normal course unless the creditor files and wins an adversary proceeding.

Often, if the bankruptcy estate has any money to pay general unsecured debts, it won’t be enough to cover all of them 100%. The bankruptcy trustee will pay some claims a percentage (pro rata). Here are some examples to illustrate what happens when not all claims can be paid in full.

Example. Anne files Chapter 13 bankruptcy. She owes the IRS $15,000, 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. 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 $12,000 in back child support, which is a priority unsecured claim. He also owes $25,000 in credit card debt. He owns an RV that he can't exempt, so the trustee sells the RV for $10,000. The trustee’s expenses, including fees, for the RV sale total $1,500. The remaining $8,500 of the proceeds will be paid toward 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.

How Are Secured Claims Treated in Bankruptcy?

A secured claim is a debt backed by collateral, and in bankruptcy, the creditor generally keeps its right to that collateral even if your personal liability for the debt is discharged. A secured creditor has a lien on your property, giving the creditor the right to take it if you default on the debt. The most common secured loans are car loans and mortgage loans, but you can also have secured loans for furniture, jewelry, watercraft, and other types of property. A claim is secured only up to the value of the collateral, and any remaining balance is treated as a general unsecured claim. (11 U.S.C. § 506(a).)

Converting a Secured Debt to General Unsecured in Chapter 7

In Chapter 7, a secured debt becomes a general unsecured claim only if you surrender the property and the sale doesn’t cover the loan. In a bankruptcy case, your liability for the debt can be discharged, but obligations arising from the lien or security agreement are not. You can choose to surrender the property to the creditor or keep it and continue paying.

If you choose to keep the property, you’ll pay back all or a portion of the claim by reaffirming the debt, redeeming the collateral, or informally paying the lender, if the lender allows it (this is sometimes done with car payments—your bankruptcy lawyer will let you know whether this is possible). Additionally, your state's laws might prevent your mortgage lender from foreclosing as long as you remain current. Again, consult a bankruptcy lawyer for your options.  (11 U.S.C. § 524(c); 11 U.S.C. § 722.)

If you surrender the property, the creditor will sell it, apply the proceeds to your loan, and treat any remainder as a general unsecured debt discharged in the bankruptcy.

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 a general unsecured claim and will be discharged in Dave’s bankruptcy.

Example. Joanne is underwater on her house; she owes $150,000 to the mortgage company, but her latest tax appraisal values it at $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 $90,000 deficiency. This deficiency becomes a general unsecured claim in her Chapter 7 bankruptcy. The mortgage was Joanne’s only debt. The trustee’s fees for seizing the investment account total $1,500, leaving $6,500 for creditors. The mortgage company receives the $6,500, and the remaining $83,500 deficiency balance is discharged.

Converting a Secured Debt to General Unsecured in Chapter 13

In Chapter 13, a secured debt becomes a general unsecured claim when you surrender the collateral, and most courts allow that. You have to decide whether you’ll keep and pay for the collateral or surrender it. If you keep and pay for it through your Chapter 13 plan, you might have some opportunities to reduce the interest rate or the loan balance. Read more about Debts You Must Pay in Chapter 13 Bankruptcy.

Some bankruptcy courts limit a Chapter 13 debtor’s ability to surrender collateral after the court confirms (approves) the repayment plan. However, most courts allow a debtor to surrender collateral well into the case and to reclassify the secured debt to a general unsecured claim. Here’s an example.

Example. Sue files for Chapter 13 bankruptcy to save her car. Her Chapter 13 plan proposes to pay the full loan balance, 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 of $3,000, which will be paid pro rata with all other general unsecured creditors.

What Is a Proof of Claim?

A proof of claim is the form a creditor files with the bankruptcy court to get paid in your case, and a trustee won’t pay a creditor that doesn’t file one. The form (Official Form 410) provides the court with information about the debt and must include documentation to support the creditor’s claim. (Fed. R. Bankr. P. 3001(c); Fed. R. Bankr. P. 3002(a).)

Sometimes money is available to pay creditors in Chapter 7, but not always. It happens only when the Chapter 7 bankruptcy trustee sells the debtor’s property. By contrast, Chapter 13 creditors receive monthly payments through a Chapter 13 repayment plan.

In most cases, creditors will file a proof of claim. But if one of your creditors fails to file a proof of claim, you can file one on its behalf if you want that creditor to get paid in your bankruptcy. Your creditor can then file its own superseding claim.

Why Would a Creditor Not File a Proof of Claim?

It is common for creditors to skip proofs of claim, and a creditor that doesn’t file won’t get paid even if it has a valid claim. Creditors file proofs of claim because they want to receive a portion of any potential distributions the bankruptcy trustee might make in your case.

A creditor might not file a proof of claim in your bankruptcy if:

• you have a no-asset Chapter 7 bankruptcy (meaning you don't have any property the bankruptcy trustee can distribute to your creditors so that they won't get paid)
• you owe the creditor a very small sum, or
• the creditor fails to follow the court’s instructions or otherwise makes a mistake.

Reasons You Might File a Proof of Claim for a Creditor

You might file a proof of claim for a creditor to make sure it gets paid, usually to pay off a nondischargeable debt or to catch up on missed secured payments. While it may sound strange to file claims on behalf of creditors in your own bankruptcy case, sometimes it can be in your best interest to do so.

You Want to Pay Off Your Nondischargeable Debts

Filing a claim for a creditor with a nondischargeable debt gets that creditor paid from your case, which means you owe less once the case closes. Certain debts don’t go away simply because you receive a bankruptcy discharge. These are called nondischargeable debts and include obligations such as alimony, child support, certain taxes, and student loans. Because you remain on the hook for paying back your nondischargeable debts after your case is closed, you want these creditors paid before your other general unsecured creditors (such as credit card companies) in your bankruptcy.

Whether you have nonexempt assets to distribute to creditors in Chapter 7 bankruptcy or you are paying off a portion of your debts in Chapter 13 bankruptcy, you want to make sure any creditors with nondischargeable debts file their proofs of claim with the court. If they fail to do so, it will be in your best interest to file a claim on their behalf so that they can receive a portion of the proceeds in your case. (11 U.S.C. § 501(c).)

You Want to Catch Up on Missed Secured Debt Payments

If you’re filing Chapter 13 to catch up on missed loan payments, you must make sure the creditors you want to pay (such as your mortgage or car lender) file their proofs of claim with the court. If you are behind on your mortgage, car loan, or other secured debts, you can file Chapter 13 to catch up on your arrears and save your property.

If they don’t file their proofs of claim, the trustee may not pay them through your plan. This means that if a secured creditor you intend to pay doesn’t file its claim, you may need to file it on its behalf.

When Can You File Proofs of Claim for Your Creditors?

You can file a proof of claim for a creditor only after the creditor’s deadline passes; then you have 30 days to do it. In most Chapter 7 and Chapter 13 cases, creditors must file their proofs of claim within 70 days after you file your case (government entities have 180 days). Before filing a claim on behalf of a creditor, you must wait until the creditor's deadline to file its own claim expires. After the deadline passes, you have 30 days to file the claim on behalf of the creditor. (Fed. R. Bankr. P. 3002(c); Fed. R. Bankr. P. 3004.)

Next Steps and Related Articles

Which category a debt falls into controls whether you’ll still owe it when your case ends, so sort each creditor into a category before you file. Online articles can’t address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer. For more helpful articles about debts and bankruptcy, try:

• Secured vs. Unsecured Debt in Chapter 7 Bankruptcy
• Unsecured Debt: Priority vs. Nonpriority
• Can I File Bankruptcy on a Judgment?