Priorities of Unsecured Claims

Debtors who seek a fresh start through bankruptcy will often have secured and unsecured debt. Usually, the unsecured debt is greater than the secured debt. Debtors generally have significant, unsecured credit card debt. With the advent of online lenders offering quick, unsecured debt to borrowers, those lenders will likely have hold significant claims in bankruptcy as well. When starting the bankruptcy process, creditors with unsecured claims can be divided into priority and non-priority claims.

Priority And Non-Priority Unsecured Claims

Unsecured claims can be divided into two categories: priority and non-priority. Any unsecured claim not entitled to priority can be paid only after full payment of all priority claims. As often happens in bankruptcy cases, unsecured claims without any priority may receive only a nominal or no distribution at all.

Priority simply refers to the order that these unsecured claims are paid per the Bankruptcy Code, or the Code. Note that priority claims are entitled to special treatment only because the Code provides for such treatment, not because the claimant has a lien or other security. The priority provisions of the Code do not apply to claimants who are secured. Secured claimants have priority as secured creditors, not as priority claimants.

Claims that qualify as priority claims are to be paid in the order set by the Code. Priority claims fall into the following categories, and are to be paid in the order discussed.

First Priority. Unsecured claims for domestic support obligations are entitled to be paid first, if, on the petition date, they are owed to, or recoverable by, a spouse, former spouse, or child of the debtor, or such child’s parent, legal guardian, or responsible relative, without regard to whether the claim is filed by such person or is filed by a governmental unit on behalf of such person. The priority is conditional: If funds are received by a governmental unit after the date of the filing of the petition they must be applied and distributed in accordance with applicable non-bankruptcy law.

The second category of first priority claims are allowed unsecured claims for domestic support obligations that were assigned, as of the date of the filing of the petition, by a spouse, former spouse, child of the debtor, or such child’s parent, legal guardian, or responsible relative to a governmental unit. Alternatively, these claims may be owed directly to, or recoverable by, a governmental unit under applicable non-bankruptcy law, on the condition the funds received post-petition by the governmental unit are applied and distributed in accordance with applicable non-bankruptcy law.  

Second Priority. Administrative expenses are entitled to second priority, as well as certain fees and charges. This category includes fees incurred to manage and litigate the bankruptcy estate. Lawyers’ fees, payments to the Trustee, and other payments fall into this category.

The reason administrative claims are given priority is that they are claims for reimbursement of expenses incurred in order to preserve and, if possible, enhance the value of the bankrupt estate for the benefit of creditors.  Another purpose of the priority afforded administrative expenses is to facilitate rehabilitation of insolvent businesses by encouraging third parties to provide those businesses with necessary goods and services. By presenting strong leadership of rehabilitating insolvent and struggling businesses, the business is more likely to gain an infusion of capital.

Third Priority. Third priority is awarded to “gap” claims, which are claims arising in the ordinary course of the debtor’s business or financial affairs during the gap after the filing of an involuntary petition, but before the earlier of the appointment of a trustee and the order for relief.

Fourth Priority. Allowed unsecured claims for wages, salaries, or commissions, including vacation, severance, and sick leave pay earned by an individual, and certain compensation of commissioned independent contractors, or corporations with a single employee, are entitled to payment as a fourth priority expense. To be entitled to priority, the wages, salaries, or commissions must be earned within 180 days before the filing of the petition and may not exceed $12,475. If the priority pertains to sales commissions earned by an individual or by a corporation with only one employee acting as an independent contractor in the sale of goods or services for the debtor in the ordinary course of the debtor’s business, then during the twelve months preceding the date of the filing of the petition, the individual or corporation must have earned at least 75% of the amount earned from the debtor.

Fifth Priority. Fifth priority is awarded to allowed unsecured claims for contributions to an employee benefit plan that arise from services rendered within 180 days before the earlier of (1) the date of the filing of the petition, or (2) the date of the cessation of the debtor’s business. As with wage claims, there is a cap on the amount payable for such claims. For each benefit plan, claims may not exceed the number of employees covered by the plan multiplied by $12,475, less the aggregate amount paid to employees as a fourth priority, and the aggregate amount paid by the estate on behalf of the employees to any other employee benefit plan.

The above outlines the priorities of distribution for creditors holding bankruptcy claims. If you are in debt, bankruptcy may be right for you. Contact the bankruptcy law firm of Melanie Tavare, a Bay-area bankruptcy lawyer.