Consequences of Priority Claim Status
Some debt in bankruptcy is "priority debt." Priority in this context is pure bankruptcy jargon - it is a label applied purely due to definitions and processes in the bankruptcy code. Whose priority are these debts? What is the effect of priority status? Should a debtor care about priority claims? We address these points and more below.
Basis of Priority Status
A debt is priority or not based on section 507 of the bankruptcy code. These definitions govern and the court resolves any disputes over applicability of the definition. Priority is not a subjective priority of the debtor or any other party. (A creditor the debtor prefers to have paid would be termed a favored creditor.)
Priority status is not a singular condition, but a ranking of priorities. Some priority debts have higher priority than others. The ranked list includes:
- Domestic support obligations, including alimony and child support
- Administrative expenses, which include items such as the chapter 7 trustee's costs and commission and chapter 13 attorneys fees, for example
- Certain post-petition claims in involuntary cases
- Claims for recent wages
- Employee benefit contribution claims
- Certain agriculture storage claims
- Claims for certain undelivered goods and unprovided services
- Many taxes
- Depository agency claims related to capital commitments
- Claims for personal injury or death due to DUI conduct
Several of these items are almost never relevant for an individual person filing bankruptcy. For people with a normal consumer debt case, the priorities list boils down to (1) domestic support obligations, (2) administrative expenses, (8) taxes, and (less frequently) (10) DUI injury debts.
Effect of Priority Claim Status
Which chapter the debtor has filed under controls how priority status impacts the bankruptcy. In chapter 7, the priority list is used to determine which unsecured creditors are paid first. Section 726 concerns distribution to creditors, and priority creditors, in the order of priority, are first in line. Accordingly, a child support arrearage would be paid before an income tax claim, while an income tax claim would be paid before a credit card. A chapter 7 may have inadequate funds to pay all claims, or even all priority claims, so having priority can be important to creditors.
In chapter 13, priority claims are treated somewhat differently. Subject to only a few exceptions, a chapter 13 plan must provide for payment in full of all priority claims under section 1322(a) of the bankruptcy code. As relatively few chapter 13 plans pay all creditors in full, priority status on a claim often results in significantly higher payments to that creditor. To proceed in chapter 13, a debtor must obtain court approval of the chapter 13 plan. The court and the standing trustee must be convinced that the plan payment is adequate to pay the priority debts and that the debtor has sufficient income to make the payments.
A priority debt should be distinguished from a non-dischargeable debt. Priority status involves being paid in the bankruptcy, while non-dischargable status involves surviving the bankruptcy to be paid afterwards. In consumer debt cases, there is significant overlap between the two, including domestic support obligations, taxes, and DUI debts. In some cases, priority status of taxes also determines non-dischargability. The full interrelationship between tax non-dischargability and priority is beyond the scope of this post.
Is a claim being priority bad?
Debtors are usually most concerned about the bottom-line of how a bankruptcy claim's treatment affects the relief they get in bankruptcy. Whether a claim is priority or not can be either subjectively good or subjectively bad from a debtor's perspective.
In chapter 7, priorities control the order in which claims are paid. If the chapter 7 is no-asset, that is the debtor has no property above and beyond the property allowances provided by the exemption statutes, neither priority unsecured creditors or general unsecured creditors will be paid by the trustee. On the other hand, if there are assets, priority creditors will get paid first. A debtor might like this, if the priority claim is also nondischargable, as the trustee would be paying a claim the debtor would otherwise have to pay after bankruptcy. On the other hand, a debtor might prefer a lower priority nondischargable claim be paid first--perhaps because that creditor will offer less favorable post-bankruptcy repayment terms.
In chapter 13, where the chapter 13 plan must propose to pay priority claims in full, large priority claims can cause debtors problems. Larger priority claims drive up the total payments required into the plan, and might raise feasibility questions on whether the debtor can afford payments as large as mathematically required. At the same time, the most common priority claims are also non-dischargable, so it can be desirable to a debtor to payoff the claim during the bankruptcy rather than after the chapter 13 case has concluded. Each debtor's plan and finances are a little bit different.
An individualized bankruptcy evaluation can help you appreciate the implications of priority claims on a possible bankruptcy case.