In bankruptcy, debts are grouped into different categories. Each is entitled to different treatment. Understanding the distinctions is critical for anyone assessing the benefits of filing bankruptcy.
Debts are first distinguished based on whether they are secured or unsecured. From there, the unsecured debts are distinguished between priority and non-priority. These distinctions are explained as follows:
Secured Debt vs Unsecured Debt
A secured debt is different from an unsecured debt in one key aspect: Secured debt is backed by rights in assets of the debtor. Those assets are considered collateral. The collateral is an asset that can be taken or sold by the creditor if the borrower fails to repay the loan. The most recognizable form of secured debt is a mortgage or deed of trust secured by a debtor’s home. In that example, the home is the asset that serves as collateral for the debt. An unsecured debt is simply a debt that does not have any asset that serves as collateral.
Priority vs. Non-Priority Debt
Both priority and non-priority debt are considered unsecured debt. In a bankruptcy context however, certain unsecured debt gets paid first – this is referred to as having priority. Non-priority debt is pretty much the lowest class of debt, and is typically paid last.
Some of the most common types of priority debts include:
- Certain tax debt;
- Alimony and child support;
- Wages, salaries, commissions, and other pay or benefits owed by an employer to employees;
- Customs, duties and penalties owed to government entities,
- Lease deposits held by landlords (where the landlord is the party filing bankruptcy), and
- Claims for death or personal injury resulting from using drugs or alcohol while operating a vehicle.
Some of the most common types of non-priority debts include:
- Credit card debts;
- Medical bills;
- Old tax debt;
- Personal loans;
- Judgments resulting from lawsuits; and
- Ordinary business debts.
While much, or all, of a debtor’s non-priority debt is frequently discharged in bankruptcy, priority debt generally must be paid. As the name would imply, priority debt is certainly given priority in bankruptcy.
For further discussion regarding the treatment of these categories of debts in bankruptcy, see this article.