There are three major categories of debt obligations in a bankruptcy case: priority claims, secured claims and unsecured claims. The categorization of a claim plays a large role in determining how much of that claim will actually be paid. In some cases, the categorization of claims can also affect the rights of the creditors.
The first category, priority claims, consists of claims enumerated in the Bankruptcy Code as having top priority with regard to repayment. This means that, even though other unsecured claims will only be paid in part, priority claims must be paid in full. There are two exceptions to this rule. The first occurs when the debtor or trustee is able to come to an agreement with a priority creditor whereby the creditor agrees to accept less than the full value of the claim. The second exception occurs in the case of domestic support obligations (alimony and child support) when the debtor can show that he or she is putting all of his or her disposable income toward fulfilling a five-year repayment plan. The term “disposable income” refers to the debtor’s income after subtracting necessary living and business expenses, child support and charitable donations up to fifteen percent of the debtor’s income. The most common priority debts are bankruptcy filing fees, taxes and domestic support obligations.
The second category, secured claims, consists of debts secured by collateral, which is an asset that the creditor is entitled to take if the debtor fails to pay back the loan. For example, home mortgages are usually secured by the house and car loans are secured by the car. If the debtor does not want the creditor to repossess the collateral, he or she must pay off the debt to the extent of the value of the collateral. If the debtor used the loan to buy the collateral or if the loan was made within a year of the bankruptcy filing, the loan must be paid in full, even if it exceeds the value of the collateral. This provision protects creditors in the case of rapidly depreciating property (e.g., a slightly used car is worth much less than a brand new car).
The third category, unsecured claims, consists of non-priority debts that are not secured by collateral. Hospital bills and credit card debt are common examples. Because unsecured claims are at the bottom of the totem pole, they are usually paid back only in part. The court is permitted to approve a repayment plan in which certain unsecured claims are paid back to a larger extent than other unsecured claims are. In order to pay only part of the unsecured claims, the debtor must put all of his or her disposable income toward fulfilling the repayment plan and must also pay each creditor at least the amount that that creditor would have been paid in a Chapter 7 version of the case.