Just as some debts are treated differently in bankruptcy – some debts can be discharged (erased) in bankruptcy and some cannot – so too are creditors treated differently in bankruptcy, so why are some creditors in bankruptcy paid while some are not?
Whether or not a creditor will be paid in bankruptcy depends on the type of debt, the chapter of bankruptcy filed, and whether the debtor has unexempt assets.
- In a no-asset Chapter 7 case, there are no funds, nothing for the trustee to seize and sell, so there is nothing to pay creditors.
- In Chapter 13 a repayment plan is created, and creditors will be paid in a certain order of priority. Some creditors may be paid in full while some creditors are paid only a portion of what they are owed or nothing at all.
The U.S. Bankruptcy Code sets forth the order of priority established for creditors who are owed money. 11 U.S.C. § 507. Some creditors will be paid before others if creditors 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 creditor in a class in-full, then each member of that class will receive a pro-rata share of the amount they are owed.
Creditors in Bankruptcy are paid in the following order of priority:
- The bankruptcy trustee assigned to administer the case.
- Unsecured Priority Claims
- Domestic support obligations – any back spousal or child support obligations owed at the time the bankruptcy case is filed.
- Certain income tax debts.
- Criminal Fines.
- Secured Creditors
- Creditors who hold a lien on property in the possession of the debtor, such as a mortgage lender or car note lender.
- In a Chapter 13 plan, a debtor may pay back mortgage arrears or missed car payments in full during the life of the plan.
- Unsecured Nonpriority Claims
- Credit card debts.
- Medical debts.
- Personal loans and student loans.
Unsecured nonpriority claims are last to be paid back from funds distributed from liquidating assets in Chapter 7 or from Chapter 13 plan payments. These creditors may be paid back in full, or partially based on a pro-rata share, or not at all.
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