Bankruptcy Basics for New and Non-Bankruptcy Attorneys
This entry is part of Nelson Mullins’s ongoing “Bankruptcy Basics” blog series that is intended to address foundational aspects of bankruptcy for new and non-bankruptcy practitioners and professionals. This entry will discuss the general structure of bankruptcy claims and the differences between how unsecured, secured, and priority claims are treated in a bankruptcy case.
A “claim” against a bankruptcy estate is defined as a:
- (A.) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; or
- (B.) right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured.
11 U.S.C. § 101(5). Accordingly, a claim can be fixed or contingent and does not have to be liquidated at the time the bankruptcy case is filed in order to be a “claim.” The existence of a “claim” is crucial, as typically only creditors with claims or other “interested parties” who are somehow impacted by the bankruptcy case can participate in the bankruptcy case.
Once you determine whether you have a claim, the most important question for a creditor to answer is what type of claim they have. Typically, there are two types of claims, with an important additional layer of analysis that must be addressed. The two types of claims are relatively straightforward to decipher, at least initially. These are (1) unsecured claims and (2) secured claims. As you can likely imagine, secured claims are those evidenced by a loan supported by a security interest in collateral. Unsecured claims are not secured by any collateral.
Generally speaking, the determination of whether a claim is secured or unsecured is critical, as it will determine where in the distribution waterfall a creditor’s claim will fall, with secured claims generally paid ahead of unsecured claims. The existence of security alone, however, is not the sole indication that a claim will be paid first. This is because of the unique structure of “priority” in bankruptcy — the additional layer of analysis that must be applied.
Priority is a bankruptcy concept that creates order to the payment of claims. Although generally unsecured claims have a lower priority than secured claims, Congress made sure to include certain unsecured claims that deserve priority treatment, even though they are unsecured. These types of priority unsecured claims are listed, in order, in Section 507 of the Bankruptcy Code, and include, in order:
- Claims for debts to spouse or children for court ordered support
- Administrative expenses of the bankruptcy
- Unsecured, post-petition claims in an involuntary case
- Wage claims of employees and independent salespersons up to $10,000 per claim
- Contributions to employee benefit plans up to $10,000 per employee
- Claims of farmers and fishermen against debtors operating storage or processing facilities
- Layaway claims of individuals who didn’t get the item they made the deposit on
- Recent income, sales, employment, or gross receipts taxes
These claims are given priority either because (A.) Congress viewed the payments as societally important such that they should be given priority (i.e., child support payments) or (B.) the claims are instrumental to the ongoing success of the bankruptcy case and the debtor’s potential rehabilitation (i.e., administrative expenses of the bankruptcy case, employee wage claims). Critically, this priority places them ahead of other unsecured claims, but not necessarily ahead of secured claims, as secured claims are paid with the collateral and proceeds therefrom.
So, when confronted with a potential bankruptcy case where you are a potential creditor, the first question you need to ask yourself is: “Do I have a claim?” In other words, does the debtor owe me goods, money, services, or anything else that the debtor has not paid/provided? If so, you likely have a claim. The next question will be: “Now that I have a claim, what kind of claim is it?” This question will likely determine how active you are in the bankruptcy case. A creditor with a high-value priority or secured claim will generally be more active in the case, as there is a greater incentive to bring about as full a payout on the claim as possible.
On the other hand, a creditor with a large unsecured claim in a case where there will be little to no distribution to creditors is likely to take a smaller role in the case, so as to not spend more money chasing uncollectable claims. Regardless of the type of claim held, the initial analysis of whether you have a claim and how that claim will be treated is the first step for any creditor facing a bankruptcy case.
Once that piece of the puzzle is unveiled, the creditor can then figure out the appropriate course of conduct for the case at hand. Critically, once a creditor determines that he or she has a claim and determined the type, the creditor should immediately file a proof of claim in the bankruptcy case. A proof of claim is a filing setting forth the extent of the creditor’s claim, the basis for the claim, the type of claim that it is, and must include attachments of any supporting documents evidencing the claim. There is a set period of time for creditors to file proofs of claim (different chapters set different proof of claim “bad dates,” or deadlines by which they must be filed). Once the claim is filed, the creditor has effectively staked his or her “claim” in the estate and can then participate in the case, as much or as little, as needed.