When it comes to who gets paid first in bankruptcy, at a very high level, a secured claim gets paid first.
A secured claim is when you have a mortgage, or a deed of trust, or a judgment lien, or a security agreement on personal property, like a car.
As a creditor, you have the right to get paid, whatever the outstanding value (the unpaid portion of the loan), or get the property that was used for collateral for the loan, whichever is less, before any unsecured creditors see any money out of the proceeds of bankruptcy.
To make that “real” assume you loaned $20,000 so that your customer could buy a car. You file a lien against the car, for the value of the loan. This is a secured Claim. The car has depreciated, and been in a few accidents, and even though they still owe $10,000, the car is now worth $1,000 for parts. You are entitled to the outstanding amount on the loan (the $10,000 that is still unpaid) or the falling apart car ($1,000) “whichever is less”. So, you could end up with the junk car, and not the cash!
The courts, in bankruptcy, can also stop the debtor from using cash collateral and collect money from a trustee’s use of a secured property that lowers its value, along with legal fees, and any interest charges that arise.
In Chapter 7 bankruptcy, there is a process called redemption. Redemption gives the person owing you the money, the opportunity to buy the asset from you the creditor, in a lump sum. That sum would have to be the real value of the asset. If you as the creditor, and the debtor can’t agree on the value, the courts are able to step in and hold a valuation meeting. In the example above, the debtor owes $10K, the car is worth $1K, and in redemption, the debtor could buy the car from the creditor for its value $1K, and own it free and clear of any debt. This might sound like a bad deal for the creditor, but would you rather have a junker that you can’t sell without a lot of aggravation or a thousand dollars? Redemption in Bankruptcy is typically an option for secured creditors.
In chapter 13 bankruptcy, things are a bit different. The person owing the $10,000 on the car mus either give the secured collateral (the junker car) to the creditor or pay off the $10,000 over the course of the court’s agreed upon re-organization plan (3 – 5 years) or the $10K can be paid off outside of the reorganization plan, usually in less time. So, let’s say that you don’t want to wait for 3 – 5 years, and you don’t want the junker sitting in your parking lot, but the debtor ends up making some money and offers to pay off the vehicle in 2 years. that would be an acceptable outcome for a creditor with a secured interest that is facing their debtor’s CH. 13 bankruptcy.
This is, of course, extremely generalized. If you are a secured creditor, or an unsecured creditor and the debtor files for bankruptcy, you are best served with legal counsel that can navigate all the many nuances of the law, to ensure that you get back as much of what you are owed as possible.
As always, the first step is to “Get On The List”, make sure you are listed as a creditor in the debtor’s bankruptcy filing, don’t simply walk away when you are told they are filing for bankruptcy.
Marcadis Singer, PA are Creditors’ Rights Attorneys. Making sure you get paid is our number one mission.