Bradley’s Bankruptcy Basics: Secured vs. Unsecured Claims
Bankruptcy mainly concerns “claims”. The debtor seeks to discharge his personal liability on the claims, while the creditors demand payment of their claims. Simply put, a bankruptcy “claim” is a right to payment. The claim does not need to be fixed, settled, uncontested or due at the time the debtor files his bankruptcy application. The official proof of claim form is discussed in more detail here.
A claim can be secured or unsecured, and this designation entails very different rights and treatment during the bankruptcy process. Creditors – anyone entitled to payment from the debtor – should have a general understanding of this designation to ensure that their claim is dealt with appropriately in bankruptcy proceedings.
Here are some of the basics of secured and unsecured debt in a bankruptcy case:
Under the Bankruptcy Code, a creditor whose right to payment is secured by a right of set-off or a lien on property holds a “secured debt”. A lien that is valid and enforceable under non-bankruptcy law, and not avoidable under the Bankruptcy Code, is equally effective in bankruptcy proceedings. A creditor with rights of set-off – the right to set-off or write off mutual debts – is also treated as a secured creditor.
The creditor’s privilege or unexercised right of set-off is his guarantee (guarantee of repayment of the obligation). For the purposes of bankruptcy proceedings, a creditor’s claim is secured up to the value of the security. Therefore, the valuation of the collateral is crucial as it determines the amount of the secured debt.
In particular, any amount of the creditor’s claim exceeding the value of the collateral is an unsecured claim under the Bankruptcy Code. Creditors should ensure that they properly disclose secured and unsecured claims when filing their proof of claim. Otherwise, the obligee may not receive payment for the missing amounts greater than the value of the collateral.
In accordance with their superior rights under non-bankruptcy law, secured creditors also have superior rights under the Bankruptcy Code. In terms of priority, secured creditors are at the top of the chain. We’ll discuss payment and priority in more detail in a future article. Other differences in treatment include:
- The right of a secured creditor to assert his lien is subject to the automatic stay of bankruptcy. In certain circumstances, a secured creditor may request a waiver of the automatic stay in order to repossess and sell their collateral.
- In a Chapter 7 case, the debtor can either abandon the collateral or reaffirm the debt and continue to make payments.
- In a Chapter 11 or 13 case, a debtor may keep the collateral if this is necessary for a successful rehabilitation plan. However, a secured creditor is entitled to adequate protection payments and full payment of his secured debt.
- Competing rights to collateral are determined in accordance with non-bankruptcy law.
- If the value of the collateral is less than the debt to the creditor, the creditor will have both a secured debt and an unsecured debt (called a bifurcation).
- The authorized unsecured debt of an unsecured creditor is generally treated like other unsecured creditors.
- In Chapter 11 cases, the creditor may choose to forgo the bifurcation of claims and be treated only as a secured creditor.
- An over-secured creditor is entitled to post-petition interest on his claim up to any increase in value of the security.
- The interest rate is the contractual rate.
- If the lien is consensual, an over-secured creditor may also recover reasonable costs and charges.
A right to payment that is not guaranteed by a guarantee is an “unsecured claim”. An unsecured creditor does not have a lien on an asset or a right of set-off. In a bankruptcy proceeding, although plans may provide for larger payments to unsecured creditors, unsecured creditors must receive at least the value of the debtor’s non-exempt assets. More information on what assets a debtor can claim as exempt is available here.
Unsecured claims fall into one of two categories: (1) senior unsecured claims and (2) general unsecured claims. Each category receives different treatment in bankruptcy proceedings.
Priority unsecured claims
Senior unsecured debts are debts that are not secured by collateral but that take precedence over other debts under federal law:
- Examples include alimony, child support, restitution, and administrative claims. The specific categories of priority debts are defined in the Bankruptcy Code.
- In a Chapter 7 case, senior claims receive full payment before any payment to general unsecured creditors.
- For a Chapter 13 or Chapter 11 plan to be upheld, the Bankruptcy Code requires that the debtor’s plan pay all senior claims in full, unless the claim holders agree otherwise.
General unsecured complaints
General unsecured claims are claims that are not secured by collateral and do not have priority:
- Examples include credit card debt, student loans, medical bills, and the unsecured portion of an unsecured creditor’s claim.
- General unsecured receivables are very low in terms of priority and often receive very minimal payment.
- General unsecured debts are usually dischargeable, which means that any amount that is not paid in bankruptcy proceedings is wiped out and the debtor is no longer liable for the debt.