How bankruptcy treats Priority debts?

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bankruptcy treats Priority debts

Debts are debts. No matter who owes whom, one needs to pay them off to regain peace of mind. Well, some debts are marked as ‘priority’. Do you want to know why? Let’s find out.

Why debts are termed as ‘priority’?

‘Priority debt’ is more like a jargon, a term that has cropped up due to bankruptcy. Individuals often do away with their unsecured debts in bankruptcy. Certain debts are allowed the ‘priority’ status so that individuals filing bankruptcy cannot just erase all their financial obligations. The priority debts are deemed more important than others and have to be paid for. If those are not paid, the individuals who owe the money can sue the debtor.

Which debts are dubbed with the ‘priority’ status?

Section 507 of the Bankruptcy Code deals with priority debts. This is because all debts can’t be specified as a priority, and the precedence of such debts vary from person to person. As per the Federal Bankruptcy Code, the “priority claims” are divided into the following 10 categories with decreasing order of priority:

  1. Domestic support obligations: These are claims for the support that is to be given to the spouse, former spouse, child, or child's representative. Any claims by a governmental unit that has extended support for the debtor's family obligations, come within this category but with a lower priority.
  2. Administrative expenses: These are expenses required to administer the bankruptcy case itself. Originally, administrative expenses had the highest priority. But with the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), the Domestic Support Obligations were lifted to the highest priority level. Nevertheless, this category has a de facto priority over Domestic Support Obligations, because such expenses are deducted from the bankruptcy estate before they are paid to DSO recipients. The courts allow the top priority for administrative expenses as no trustee will oversee a bankruptcy case for nothing.
  3. Claims in an involuntary bankruptcy petition under Chapter 7 or Chapter 11: Such claims arise between the filing of the involuntary petition by the debtor's creditors and issuance of the relief order by the court. These claims need to be prioritized, or else creditors would not deal with the debtor in a situation where the debtor has not declared bankruptcy, and the court has not yet ruled in the creditors' favor.
  4. Employee wages: Employee wages up to $13,650 per worker, for the 180 days before either the bankruptcy filing or when the business ceased to operate (whichever is earlier).
  5. Unpaid contributions to employee benefit plans during the 180 days before the bankruptcy filing.
  6. Claims by a grain producer by a fisherman for grain/fish, for up to $6,725 per grain-producer/fisherman.
  7. Consumer layaway plan deposits up to $3025 each.
  8. Taxes outside of bankruptcy: Normally taxes have a higher priority, when they are outside the purview of bankruptcy. Therefore, creditors prefer to file an involuntary bankruptcy petition against the debtor, so that they can receive more priority in bankruptcy than they would outside it.
  9. Debtor's obligation to a Federal depository institution to preserve the capital of the institution.
  10. Claims for death or personal injury from a motor vehicle that occurred while the debtor was driving it and was intoxicated.

Every category of priority creditors must be paid in full before the next category of creditors can receive their payment. Normally, unsecured creditors receive the lowest priority. If there is not enough money left to pay a priority category in full, then all the members of that category receive a pro-rata share of the leftover.

What are the exceptions to the pro-rata disbursement?

There are 2 exceptions to the pro-rata distribution within a priority category:

  • In case of domestic support obligations, individual claimants have priority over governmental claims.
  • If a Chapter 11 case is converted to a Chapter 7 case, then the administrative expenses of the Chapter 7 case will have priority over the replaced Chapter 11 expenses.

Can the priority order be changed?

State laws can neither modify the priority of claims nor can disregard the priority order. Even, the courts are not empowered to modify the order under normal circumstances. However, some specific types of payments are granted a de facto priority by the courts. These are usually prioritized to achieve some legal solutions, such as resolving conflicting legal objectives, paying the trustee to oversee the bankruptcy case, and so on.

How Priority Claims are treated during bankruptcy?

Depending on which form of bankruptcy has been filed, whether it’s Chapter 7 or Chapter 13, the priority debts are treated differently.

Chapter 7 Bankruptcy

Priority debts determine which of the unsecured debts on the individual’s list has to be paid first. Having priority status is important for the creditors since an individual filing Chapter 7 will not have sufficient funds to pay all the debts or even for all the priority debts. Consequently, the rest of the arrears on the priority list and the general unsecured debts are discharged. Child support, alimony, or income tax claims are thus paid before the credit card bills in Chapter 7 bankruptcy.

Chapter 13 Bankruptcy

All of the priority claims are paid-in-full by an individual opting for Chapter 13. The creditors having the priority debts are often entitled to higher premiums and the payment plan of the debtor is set accordingly. However, the court and the standing trustee need to approve the payment plan and see to it that the debtor has adequate income to make the payments.

What is the difference between priority debts and non-dischargeable debt?

Priority debts and non-dischargeable debts are often confused, since most of the time, they overlap each other. Debts enlisted with the ‘priority’ status have to be paid in the bankruptcy or else discharged. The non-dischargeable debts have to be paid even after the bankruptcy, i.e. they survive the bankruptcy. Nevertheless, under certain circumstances, the priority status of debt makes it non-dischargeable.

Under Chapter 7, the creditors, having priority claims, only get paid if the individual has assets. Large priority claims may drive up the total payments under Chapter 13.

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