"Priority" Debts in Bankruptcy

 Posted on September 05, 2016 in Bankruptcy Law

What makes “priority” debts so special?

Your debts fall into three categories:

• Secured
• General unsecured
• Priority

We’ve spent many blog posts covering secured and general unsecured debts. Today it’s time for priority debts.

Priority Debts

Just like it sounds, priority debts are treated in bankruptcy law as more important than other debts. They’re more important, essentially, than “general unsecured” debts.

Debts that are not secured by liens on anything you own are all unsecured debts. Just about all unsecured debts are “general unsecured” ones.

Priority unsecured debts are simply certain kinds that the law has selected to be treated with higher priority than other debts.

Why Are They Treated with Higher Priority?

For each type of priority debt there are reasons why it is treated special.

There are really only two types of priority debts in most consumer bankruptcy cases:

• child and spousal support—the amount of support owed as of the time of the filing of your bankruptcy case
• certain income taxes, and some other kinds of taxes—they are priority debts only if they meet certain conditions

Support payments are treated special simply because Congress has decided that this kind of debt should be favored over other debts in bankruptcy. In fact, it is treated with the very highest priority of all priority debts. When money is distributed through bankruptcy procedures, support debts are usually paid first, ahead of all other debts.

Certain income tax debts are treated special because taxes benefit the public, so Congress has decided taxes should be favored. Unlike unpaid support payments, for income taxes to be priority they have to meet certain conditions. Those conditions mostly have to do with how old the taxes are. The newer the tax is the more likely it is to be priority. Otherwise, (older) income taxes are just general unsecured debts.

How Do Priority Debts Have Higher Priority in Bankruptcy?

In bankruptcy, a lot turns on which debts get paid ahead of other debts. That’s because the amount of money available is usually much less than the amount of debt to be paid. So, often all of the money, or most of it, goes to priority debts.

This plays out differently under Chapter 7 “straight bankruptcy” and under Chapter 13 “adjustment of debts.”

In most Chapter 7 cases the bankruptcy trustee does not take possession of any of your assets to distribute to your creditors. Because there are no funds for the trustee to pay any debts, priority debts do not come into play. But there are (relatively few) cases where there are unprotected assets for the trustee to liquidate. In those cases the trustee must pay the priority debts in full before paying the general unsecured ones anything. And the trustee must pay higher priority debts in full before paying the lower priority ones anything at all.

In Chapter 13 cases, you and your bankruptcy lawyer propose a payment plan that you present to the bankruptcy court. That payment plan must show how you will pay all priority debts in full during the 3-to-5-year case. Creditors can object, and after any objections are resolved, the court approvals a plan. Then during the course of the case you must in fact pay all the priority debts in full before you can complete the case and get a discharge (legal write-off) of your remaining unpaid debts.

The next blog post or two will show how priority debts work in practice.