When you file for bankruptcy, the debts owed to creditors are called “creditor claims.” Not all claims are treated the same way in bankruptcy, with more critical or "priority" claims being paid before others. The bankruptcy trustee appointed to the case determines how to pay creditors when money is available for distribution.
How a Creditor Asks for Claim Payment in Bankruptcy
When money is available, the trustee sends out an asset case notice and gives creditors a deadline for requesting a portion of the funds. Creditors ask for claim payment by completing a Proof of Claim (Form 410). The Proof of Claim requires the creditor to prove that the bankruptcy filer owes the debt.
The form asks about the type of debt, the amount owed, and the creditor’s right to payment. It also provides other information a trustee needs to know before making a payment, including the following:
- Is the claim backed by collateral? A claim is either secured by collateral (for instance, a mortgage or car loan) or unsecured (like a medical bill or credit card balance).
- Should the claim move to the head of the line? A priority unsecured claim gets paid before other unsecured claims.
- Can the claim be paid now? Any claim labeled contingent, unliquidated, or disputed isn’t ready for payment.
How a Debtor Lists a Claim in Bankruptcy
When disclosing debt on the proof of claim form, a debtor must sort claims into two categories, as follows:
Secured claims. A secured claim is guaranteed by "collateral" or property. This ownership right creates a lien on the property, so if the debt isn’t paid, the creditor can take and sell the collateral. Examples of voluntary liens include a security interest in real estate or personal property, such as a car, truck, or machinery. A taxing agency or a court's lawsuit judgment can create an involuntary lien.
Most liens don't go away in bankruptcy, which preserves the creditor's ability to be paid. The creditor can use the lien to recover the property after bankruptcy or during bankruptcy with the court's permission. Because of this, the trustee rarely pays secured creditors. You'll list secured claims on Schedule D: Creditors Who Have Claims Secured by Property.
Unsecured claims. A claim that isn’t backed by collateral is unsecured. Credit is extended solely on the borrower's creditworthiness and ability to pay. A credit card balance is a common unsecured debt. The debtor lists these claims on Schedule E/F: Creditors Who Have Unsecured Claims.
The form also notes a claim that is partially secured and unsecured. Additionally, the creditor must attach a copy of the contract or document that gives the creditor the legal right to collect the claim.
When a Claim Is Entitled to Payment Priority
Both debtors and creditors must indicate whether an unsecured claim is a priority claim entitled to payment before others. Priority unsecured claims include:
- administrative expenses (allowed expenses incurred by the trustee)
- domestic support obligations (alimony and child support)
- deposits toward the purchase, lease, or rental of property or services for personal, family, or household use (up to a fixed amount)
- wages, salaries, or commissions earned within 180 days before the filing (up to a fixed amount)
- taxes or penalties owed to governmental units
- contributions to an employee benefit plan, and
- claim for death or personal injury resulting from intoxication.
When there isn't enough money to pay all claims in a case, unsecured claims with the highest priority stand the best chance of being paid compared with claims with a lower ranking.
When a Claim Needs More Information
Not all claims are ready for immediate payment. If more information is necessary or something needs to happen before a debt comes due, the debtor will alert the trustee and creditors by labeling a secured or unsecured claim as either contingent, unliquidated, or disputed. Here’s what each term means.
Contingent claim. This type of claim is owed only if a specific condition occurs. For instance, a debtor might be a loan co-signer who must pay only if the borrower doesn't make the loan payments. A contingent debt is one in which there is a triggering event for the debt to exist, but all the events needed to create liability haven't happened before filing the bankruptcy petition.
Unliquidated claim. The amount owed on this type of claim hasn’t yet been determined. For instance, suppose the filer is getting sued for injuries related to an automobile accident, but the action still goes through the court system. The claim amount will remain unliquidated until the related lawsuit is completed and a judgment for damages is entered against the debtor.
Disputed claim. A disputed debt is one that you disagree you owe to the creditor. If you agree to the amount, the debt is undisputed.
Paying Secured, Priority, and General Unsecured Claims
After the trustee has all available funds together and has reviewed the claim forms, the trustee will sort the unsecured claims into the two types of claims the trustee pays, which include:
- priority unsecured claims, and
- general unsecured claims.
The trustee must pay priority unsecured claims in full before making payments to unsecured creditors. For instance, qualifying income tax balances will be paid before a medical bill. The trustee rarely pays secured claims (more below).
Paying Claims in Chapters 7 and 13
While trustees follow the above rules, claim payment is a bit different in each chapter from a practical standpoint. In Chapter 7, the trustee is primarily responsible for liquidating property and paying unsecured claims. After the trustee pays all priority unsecured claims, general unsecured claims will receive a pro rata share of the remaining funds.
The Chapter 7 trustee will only pay a secured creditor claim if the trustee sells the property, usually a house or car. In that situation, the property must be worth enough to fully repay the secured debt and have money remaining to pay unsecured creditors.
Example. The Chapter 7 debtor owns a house worth $300,000. The debtor can protect $50,000 with a bankruptcy exemption, leaving $50,000 in equity to pay creditors. The trustee will sell the home, pay off the $200,000 mortgage, give the debtor the $50,000 exemption amount, and use the remaining balance to pay unsecured creditors.
In Chapter 13, the same general rules apply. However, the trustee doesn't sell property. Instead, the trustee disperses the funds received from the filer according to the confirmed (approved) repayment plan. Depending on the plan and the rules of the jurisdiction, payment might be made to both secured and unsecured creditors.
Time to File a Proof of Claim
Filing claim times differ based on whether the debt is owed to a government or nongovernment creditor. The time limits are as follows:
- Nongovernmental creditors. A nongovernment creditor has 70 days to file a proof of claim after the petition filing date in Chapter 7, 12, or Chapter 13.
- Government creditors. These entities must file a proof of claim within 180 days after the bankruptcy filing date.
The particular date will appear in the notice sent out by the bankruptcy trustee.
Objecting to a Proof of Claim
A claim doesn't automatically get paid. A trustee, creditor, or debtor who disagrees with the claim can file an objection with the court. The dispute will be resolved by a judge on the submitted paperwork or at a hearing.
Meet With a Lawyer
Sorting through these issues can be complicated, and it’s a good idea to seek help from a bankruptcy attorney. A good place to start is by finding out the average cost of filing for Chapter 7 and Chapter 13 bankruptcy.