Navigating Priority vs Non-Priority Debts in Bankruptcy
Navigating a financial crisis can be overwhelming, especially when it comes to understanding where you stand with debt. If you’re considering bankruptcy, you’ve likely come across the phrase “priority vs non-priority debts in bankruptcy” and felt a bit lost. But don’t worry; understanding this distinction is essential to making informed decisions. In this blog post, we’ll break down this complex topic into clear, simple terms, helping you understand how it all works.
What Are Secured and Unsecured Debts in Bankruptcy?
To grasp “priority vs non-priority debts in bankruptcy,” we must categorize your debt into two types: secured and unsecured. Let’s explore why this difference is so important.
Secured Debt
Secured debt is a loan backed by something tangible, often called collateral. If you’ve ever gotten a car loan or a mortgage, you’ve encountered secured debt.
You make payments, and everything is fine, but if you default, the lender can seize the collateral – the car or house – to make up for their loss. Schedule D is the form for listing these creditors and the debts you owe.
Unsecured Debt
With unsecured debt, no specific asset guarantees the loan. Credit card balances, medical bills, and utility bills usually fall under this category.
If you don’t pay, the creditor has fewer direct ways to recoup their losses. Since no asset secures the debt, these debts are typically discharged through bankruptcy. However, suppose a creditor obtains a judgment against a debtor, and a lien is attached to one of their assets before filing bankruptcy. In that case, that debt will be treated as a secured debt. Schedule E/F will be where these debts and creditors are listed on bankruptcy schedules.
Breaking Down Priority and Non-Priority Debts
So, where does “priority vs non-priority debts in bankruptcy” come into play? This categorization applies only to unsecured debt and determines the order in which debts are repaid during a bankruptcy case.
Essentially, bankruptcy law dictates that some unsecured debts are more important to address quickly than others.
Priority Debts
Think of these debts as having VIP status. The bankruptcy process puts them at the top of the list.
Why? Usually, this VIP treatment comes down to what Congress deems crucial for the greater good or fairness, like certain taxes or overdue child support payments. There are very specific unsecured debts that Congress decided were important enough to be treated differently in a bankruptcy and not be discharged. You find more on this in Bankruptcy Code Section 507.
Examples of Priority Debts:
Child support and alimony.
Certain types of recent taxes.
Wages owed to employees.
Debts incurred after filing for bankruptcy to continue business operations.
Why It Matters
Priority debts usually can’t be erased in bankruptcy. Even after Chapter 7, you’ll likely still owe a balance. Because they’re top priority, any money recovered from the sale of assets during a Chapter 7 case goes towards these debts first.
Chapter 13 typically requires that priority debts be paid in full over your three-to-five-year repayment plan.
Non-Priority Debts
These debts are further down the line. Examples include credit card debt, personal loans, and old utility bills–think of them as everyday expenses, not tied to vital societal concerns like priority debts.
In Chapter 7 bankruptcy, these often get discharged completely, meaning you no longer owe them. With Chapter 13, you may end up paying only a small fraction of what you originally owed. Many wonder about the dischargeability of specific debts, such as student loans, and if they will receive payment through the bankruptcy process.
Examples of Non-Priority Debts:
Credit card balances.
Medical bills.
Personal loans.
Older tax debt.
Student loans ( these usually cannot be discharged in bankruptcy[2], though there are some exceptions.)
Keep in mind that priority debt must be repaid before nonpriority debt is addressed in either Chapter 7 or 13 Bankruptcy. Non-priority unsecured claims and non-priority unsecured debts have a lower payment priority.
Real-World Impact
Let’s look at how “priority vs non-priority debts in bankruptcy” can affect your situation. Imagine you file for Chapter 7, and the court sells your boat, which brings in $10,000.
If you owe $8,000 in back taxes (priority debt) and $6,000 in credit card bills (non-priority), the entire $8,000 from the boat sale goes toward the taxes, and you’re left with a smaller tax debt to handle post-bankruptcy. The credit card bills would likely be wiped out.
FAQs about Priority vs Non-Priority Debts in Bankruptcy
What is the difference between priority and non-priority debt?
The distinction impacts how unsecured debt is handled in a bankruptcy case. Priority debts, those considered important for fairness or the greater good, must be addressed first. Non-priority debts are treated with lower urgency during repayment.
What is the difference between priority and non-priority claims?
Claims filed by creditors are categorized as priority or non-priority, reflecting how vital it is to repay those debts quickly. This classification determines the order in which the bankruptcy estate distributes any recovered funds. This impacts whether an unsecured creditor will receive payment, and is an important concept within bankruptcy law.
What is the difference between priority and non-priority tax debt?
Certain newer tax debts, often deemed important for government functioning, hold priority status during bankruptcy. Older tax debts or penalties, seen as less crucial, generally fall under non-priority. The timeline for when a tax debt transitions from priority to non-priority is determined by the Bankruptcy Code.
What is the priority of payments in bankruptcy?
During a bankruptcy case, secured creditors (with collateral backing their loans) are usually the first to be paid from the sale of any assets. After addressing secured claims, the focus shifts to paying administrative expenses and priority unsecured debts. Any remaining funds then go towards non-priority claims. Bankruptcy laws ensure essential or fairness-driven debts take precedence over more standard consumer obligations. When filing Chapter 7 or Chapter 13 bankruptcy, priority unsecured claims come before nonpriority unsecured claims.
Conclusion
Grasping the distinction between “priority vs non-priority debts in bankruptcy” is a big step toward navigating your financial options. While this blog can’t cover every scenario, hopefully, you better understand how your various debts might be addressed. Of course, seeking guidance from a knowledgeable bankruptcy attorney is always recommended to understand how “priority vs non-priority debts in bankruptcy” impacts your situation. They can analyze your unique circumstances and debts to help you make the most strategic decisions for your financial future. The Law Offices of William Waldner would be happy to speak with you. Contact us today to request a free consultation.