This class of creditors is typically the first to receive payment in Chapter 11 bankruptcy cases. Secured creditors are those whose claims against the debtor are secured by something tangible or measurable. A common example of a secured creditor is a bank that has financed a mortgage; in this case, the real estate or piece of property purchased acts as collateral for the loan. In a Chapter 11 bankruptcy, secured creditors receive either the return of their collateral or the value of the collateral in cash. If the collateral is worth less than the secured creditor’s total claim, the remaining portion of the claim is converted into a second, unsecured claim that is handled along with all other pro rata payments to unsecured creditors.
This class of claims applies primarily to debtor-in-possession financing, where a creditor has loaned money to a debtor after the debtor has filed a bankruptcy petition. In Chapter 11, such loans are usually made in order to allow the debtor to continue its business operations as a reorganization plan is prepared. As it is understandably a riskier proposition to extend credit to a debtor who is already in bankruptcy, these claims are allowed to “jump the queue” of other unsecured claims, and be treated next in the priority line after secured creditors have been paid.
Unsecured creditors: 10 categories of priority claims
Section 507(a) of the Bankruptcy Code outlines the order of priority in which unsecured claims are treated; note that this priority schedule concerns all types of bankruptcies, and so some specific types of claims may be less relevant to or common in Chapter 11 cases. The following 10 claim types, in order, are handled before any other “general” unsecured creditors can receive payment. These general unsecured claims are paid on a pro rata basis.
Domestic support obligations
These are claims that are due to a current or former spouse, a child, or a child’s representative. Also treated within this category, though at a lower priority, are claims due to a government unit or entity that has provided support assistance for the family obligations of the debtor.
These are the necessary costs that are incurred during the administration of the bankruptcy case itself, including fees for professionals, such as attorneys or accountants, who are retained in the case.
These are claims that occur in an involuntary bankruptcy petition, between the time when an involuntary petition is filed by the debtor’s creditors and the time when an order for relief is issued by the court. These claims have such a high priority because otherwise, no creditors would wish to deal with a debtor during the tenuous period in which the debtor has not declared bankruptcy, but neither has the court yet ruled in favor of the creditors who have filed the involuntary position. The priority scheme here is designed to help keep the debtor’s business functioning while the post-petition proceedings are being determined.
Employees are entitled to claims for salary, commissions, and other benefits earned during the 180-day period immediately prior to the bankruptcy, or immediately prior to the business ceasing operations, whichever is earlier. The amount of this claim is subject to a cap that is adjusted every three years. Until April 1, 2016, each worker may claim up to $12,475.
Employee benefit plans
These claims concern contributions to employee benefit plans during the same 180-day period described above.
Claims from grain producers or fishermen
These claims are typically made against storage or processing facilities; each grain producer or fisherman may claim up to $6,150. This amount is also adjusted every three years.
Consumer layaway deposits
These claims are typically made by individuals and concern deposits made on leases or purchases intended for personal, family, or household use. Claims may be up to $2,775 each, and like the other caps, this amount is also adjusted every three years.
Unsecured pre-petition taxes
There are several important points to note about how tax claims in bankruptcy are handled. One is that taxes often have a higher priority outside of bankruptcy than they do in a bankruptcy case; on the statutory priority ladder, taxes stand only in eighth position. This is one of the most common reasons why creditors will force a debtor into involuntary bankruptcy: so that they can receive higher priority treatment over tax claims than they otherwise would. It is also important to be aware that this priority level applies only to unsecured tax claims, although in many cases, the tax collector may have a kind of secured claim in the form of a statutory tax lien, and thus may have the potential to be treated as a secured claim. Finally, this priority applies only to tax claims, and not to other non-tax claims from the government.
These claims concern those commitments made by the debtor to the regulatory agency of a federal depository institution for capital maintenance of the institution.
Death or personal injury
These are claims made for death or personal injury that resulted from a motor vehicle or other vessel accident that took place when the debtor was legally intoxicated.