Bradley’s Bankruptcy Basics: Payment of Claims

Bradley Arant Boult Cummings LLP

One of the first things creditors ask after filing a proof of claim is, “when do I get paid?” As with so many other legal questions, the answer is, “it depends.” Although many different factors govern payment in a bankruptcy proceeding, there are four key elements to payment: proof, allowance priority, and timing.

Below, we discuss these elements and how they may vary depending on the type of claim and the chapter of the bankruptcy proceeding. Please also refer to this chart for more information regarding when claims are paid in various types of bankruptcy cases.

1. Proof

All creditors must prove their claim by the applicable deadline (the bar date) in order for their claim to be allowed in the bankruptcy proceeding. Creditors prove their claims by filing a “proof of claim” (POC). More information regarding how to file a POC can be found here and a sample POC and information regarding how to complete the official POC form are available here.

Failing to timely file a POC does not invalidate a secured creditor’s lien against property. However, a creditor’s failure to file a POC may lead to a secured claim not being allowed (absent such claim’s inclusion on a debtor’s schedules of assets and liabilities). Additionally, an under-secured creditor must prove its claim to receive a distribution on the unsecured portion of its claim (more information about secured and unsecured claims is available here).

2. Allowance

If a creditor timely files a POC, the claim is deemed allowed unless a party in interest files an objection to the claim. The Bankruptcy Code uses the phrase “party in interest,” which means objections are not limited to the debtor. Why object? A debtor may seek to reduce its payments under a rehabilitation plan. A creditor, or other party in interest, may seek to reduce the number of allowed claims in order to increase its individual distribution amount.

The specific grounds for disallowing a claim are set forth in the Bankruptcy Code. However, the Bankruptcy Code includes a general objection — that the claim is unenforceable against the debtor and property of the debtor, under any agreement or applicable law — which permits objections on the merits of the claim under non-bankruptcy law. A claim amount may also be reduced in the amount that it is allowed through an objection.

3. Priority

Secured claims are satisfied by the collateral or its proceeds. All other claims are paid from the general funds of the debtor’s bankruptcy estate. The priority — or ranking — of claims is the same whether under Chapter 7, 11, or 13. However, the rules governing the treatment of claims are different in a Chapter 7 than in the other chapters.

In a Chapter 7 case, the funds received from liquidation of the debtor’s non-exempt estate property are applied to each class of priority by rank. The distributable funds flow in a “waterfall” type fashion, paying each senior class in full before moving to the next class for distribution until the distributable cash runs out. Generally, if funds are insufficient to pay a class in full, the funds are shared pro-rata by all members of the class. Because general unsecured claims are so low in terms of priority, they often receive very minimal payment or are discharged with no payment at all from an insolvent case.

For a Chapter 11 or Chapter 13 plan to be confirmed, the Bankruptcy Code requires that the debtor’s plan pay all priority claims in full unless the holders of the claims agree otherwise. Accordingly, the ranking of various priority classes does not have as much meaning as it does in Chapter 7.

Please consult this chart for more information regarding the priority order in which claims are paid under the Bankruptcy Code.

4. Timing 

Generally, in a Chapter 7 case claims are paid near the end of the bankruptcy proceeding after creditors have filed POCs and the Chapter 7 trustee has liquidated the debtor’s assets.

In Chapter 11 and Chapter 13 cases with plans of reorganization (rather than liquidations), most payments to creditors begin after the plan has been confirmed. Notably, though, a Chapter 13 debtor must begin making plan payments to the Chapter 13 trustee 30 days after the Chapter 13 case is filed, and the Chapter 13 trustee generally holds those payments until the plan is confirmed. Creditors will continue to receive payments on their claims over time in accordance with the terms of the confirmed plan. However, under some circumstances, creditors may receive payments before the plan is confirmed, if appropriate (e.g., a secured creditor may require adequate protection payments prior to plan confirmation).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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