Chapter 7 Bankruptcy: How Do Creditors Get Paid?

You’ve filed Chapter 7 bankruptcy in New York and there were assets that were sold by the trustee and turned into cash.  Now you’re wondering just how your creditors are going to get paid.

Will the tax collector get first crack at the money, or will the student lender?  How about the mortgage company?  Or child support?

There is a pecking order when it comes to getting paid in bankruptcy, and that pecking order is pretty strict.  Six classes of priorities, and they come one after another.

But first, creditors need to file a Proof of Claim in order to be paid.  If no Proof of Claim is filed, the creditor doesn’t get paid.  Period.

Once they do, who comes first?  Simple, really – all we do is look to the U.S. Bankruptcy Code for guidance.

First people who get paid are those who have valid liens on property.  So if your house is sold, the mortgage company gets the first bucket of money when the house is sold.  Makes sense, right?

OK, now onward to the next segment of creditors, which are called priority creditors.  Within that broad category, the segment gets chopped up as so:

First, domestic support obligations get paid.  Those are debts to a spouse, former spouse, or child of the debtor, or such child’s parent, legal guardian, or responsible relative.

Next, any administrative expenses due to the trustee are paid.

Third, any other allowed administrative expenses such as legal fees approved by the court.

Fourth, certain claims in involuntary bankruptcy cases (if someone files an involuntary bankruptcy against you, let me know in advance because I can’t help with those).

Fifth, up to about $11,000 in wages earned by employees of the debtor within 180 days prior to filing the case, followed by money to have been contributed to a business debtor’s employee contribution plan during the same period of time.

Next, allowed unsecured claims of individuals, up to $2,425, arising from the deposit, before the commencement of the case, of money in connection with the purchase, lease, or rental of property, or the purchase of services, for the personal, family, or household use of such individuals, that were not delivered or provided.

Followed by tax debts that are not otherwise dischargeable under Chapter 7.

Finally, allowed claims for death or personal injury resulting from the operation of a motor vehicle or vessel if such operation was unlawful because the debtor was intoxicated from using alcohol, a drug, or another substance.

Once those priority creditors are paid, the rest of the debts are paid out in pro-rata fashion (in other words, the money is divided according to the percent of the total unsecured debt owed to each creditor).  Assuming everyone is paid in fully, everyone gets interest at the legal rate of interest.  And once that gets paid in full, the balance comes back to the debtor.

So what does this mean for most people who file for Chapter 7 bankruptcy?  The reality is that most Chapter 7 cases are considered “no asset” cases, which means there’s nothing to liquidate and divide.  For the few cases that have nonexempt assets, the domestic support obligations get paid first.  After that the trustee gets paid his or her administrative expenses, the tax man gets his pound of flesh, and the unsecured creditors fight over the scraps.

But again – there typically isn’t anything to fight over.  If there are, chances are pretty good that a smart bankruptcy lawyer would do what he or she could to get you into a Chapter 13 bankruptcy if at all possible.

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Check Out These Related Posts:

1. Can Creditors Force You To File For Bankruptcy?
2. Chapter 7 Bankruptcy Trustee Role In New York
3. Automatic Stay Relief – How And When Creditors Get It