Creditors are people or entities who have a right to payment from the debtor who is filing for bankruptcy. When a person files for bankruptcy, and becomes a debtor, there is an order of priority established among the creditors who are owed money.
This means that some creditors will be paid before others, if they are paid at all. Creditors are divided by classes, and each class is paid in full before the next class is paid.
If there is not enough money to pay each member of the class in full, each member will receive an even percentage. This is true regardless of the type of bankruptcy filed, although priority may differ depending on the type of bankruptcy filed.
For instance, domestic support must be paid before employee benefits. If the bankruptcy debtor has $5,000 in the debtor’s estate and the debtor owes $4,000 in domestic support, employees of the debtor will only be paid $1,000. If the employees are owed more than $1,000, then the $1,000 will be distributed evenly among those employees.
Does the Priority of Distribution Apply to All Types of Bankruptcy?
Yes. There are several types of bankruptcies. Chapter 7 bankruptcies are most common among individuals who do not have many assets. This is known as a liquidation bankruptcy. A chapter 13 bankruptcy is a repayment bankruptcy.
No property is liquidated, and it allows debtors to start payment plans to repay their creditors. Chapters 11 and 12 are also repayment bankruptcies. However, Chapter 11 is used by large corporations, and Chapter 12 is used by farmers and fishermen.
The creditor priority rules do apply to all types of bankruptcies, however, the order of priority varies according to the type of bankruptcy.
In Chapter 7, where non-exempt property is sold, the creditors are paid from the profits by priority. In Chapter 11 or 13, the creditors are repaid according to the repayment plan, which must conform to the priority rules.
Why are Some Creditors Paid Before Others?
Creditors are paid in a certain order in order to protect creditors society believes should be protected. Bankruptcy administers are always paid because the law needs administers in order for the bankruptcy system to function, domestic support is protected because society wants to protect families, and so on.
Which Creditors Have Priority?
The first party to be paid is the United States Bankruptcy court in which the bankruptcy is filed. The court charges fees for filing.
After that, secured creditors are paid. Secured creditors are those who hold a lien on some property in the possession of the debtor. For example, mortgages on homes and unpaid balances on cars are held by secured creditors.
Secured creditors are always paid because the collateral property the secured creditor claims legally belongs to the creditor unless the debtor paid off the loan.
The next class of creditors to be paid are unsecured creditors. No property is involved that these creditors may repossess. The first among unsecured debts to be paid is any kind of domestic support, namely, child support or alimony. The courts have an interest in seeing the debtor’s family supported.
The second class of unsecured creditors are the costs of administration in bankruptcy. The cost of administration in a bankruptcy case includes referee’s fees, trustee’s fees, clerk’s fees, witness fees, and accountant fees (if approved by court).
The cost of administration also includes "one reasonable attorney’s fee." Services rendered must specifically be for the bankruptcy, and directly related.
The next major class of creditors is employees. Employee wages, salaries, commissions and benefit plans are paid after the bankruptcy court, secured creditors, domestic support, and cost of administration have been paid.
Interestingly, employees have a payment cap and a time cap. Each employee may only collect up to $11,725 and only if the employment compensation was earned 180 days before the employer filed for bankruptcy.
The last major priority unsecured creditors are government taxes. "Taxes" includes income, property, employment and any tax the debtor is liable in whatever capacity.
However, each individual tax is subject to a different time cap. For instance, a property tax can only be collected if the tax was incurred one year before the commencement of the case.
Do I Need an Attorney?
Some very simple Chapter 7 bankruptcies can be filed pro se, meaning on your own, without the help of an attorney.
Other bankruptcies will almost always need the assistance of an attorney, and even basic Chapter 7 bankruptcies can be complicated. If you are considering bankruptcy, you should also consider at least consulting with a local bankruptcy attorney for help.