Bankruptcy Debts and Treatment
Whether you file a Chapter 7 or a Chapter 13, or any of the others, your debts will be categorized and paid based on the kind of debt involved. Debts can be administrative, priority secured, non-priority secured, priority unsecured, and general unsecured, but you may also have unexpired leases and executory contracts. Payments are generally made in this order, though you may skip over some creditors depending on other factors.
In a Chapter 13, Administrative debts are the Trustee’s percentage, and your Chapter 13 Attorney’s fees. In a Chapter 7, only the Trustee’s percentage is an administrative debt.
Priority Secured and Unsecured Debt
Priority debts come in two flavors: secured, and unsecured. These are often unpaid taxes, but there are other types of priority debts as well. A tax lien is an example of a secured priority debt. The debt is an unsecured debt if the government did not record a lien. These debts also have different treatment from Chapter 13 to Chapter 7. In a Chapter 13, all priority debts must be fully paid to get a discharge. In a Chapter 7, you can get a discharge without having to pay priority debts, though the priority debts may not be discharged.
Dischargeability of Taxes
In some cases your unpaid taxes can be discharged without any distribution to any of your creditors. Dan Mueller, a Pennsylvania bankruptcy attorney has written a really good description of when this applies, so rather than re-write this, follow this link for his explanation of when taxes may be dischargeable. Some tax debt is not priority debt. The proof of claim they file will identify what portion is secured priority debt, what portion is unsecured priority debt, and what portion is unsecured non-priority debt. But sometimes they are not correct. When that happens, your attorney will need to object to the proof of claim, and if a hearing is required your attorney will need to explain what is wrong with the proof of claim.
Non-priority Secured Debt
A example of a non-priority secured debt is a car loan or a home loan. People often file Chapter 13 cases to resolve arrearages on a secured loan. The arrearages will be paid with plan payments. Another reason to file a chapter 13 is to cram-down the principal of a secured loan. The most common application of this is when a Debtor owes more for their car than it is worth. As long as they purchased it 910 days or more before the case was filed, they can satisfy the debt in full in the Chapter 13. For example, they may owe $20,000 to a lender, but the vehicle is only worth $13,000. Rather than continuing to make payments of $350, $400, or more, they can pay for the vehicle in the Chapter 13 plan. In a five year plan, this will effectively reduce their payment on the vehicle to less than $220. Although it does not exactly work this way, this is a good approximation.
In a Chapter 7, a redemption is available as a means of cramming-down what the secured lender may receive. Like our example above, if you owe $20,000, but the vehicle is worth $13,000, you can pay the lender $13,000 and satisfy the debt in full. Sometimes you can do this by paying the debt with a 401K loan or using other exempt property. But there are also lenders that will loan you the money for the redemption. I usually send my clients to 722redemption.com for the loan they need.
Of course, you do not always need to pay a secured creditor in a Chapter 13 plan or in Chapter 7. In Chapter 13, some jurisdictions require conduit payments for your primary residence, some do not, and still others only require it when you are not current with your payments. A conduit payment is when you send your payment through the Trustee, and the Trustee makes the payment to the lender. In Arizona, only one Trustee requires conduit payments, and only when you also have to pay an arrearage. However, all jurisdictions require you to pay off any cars in the bankruptcy if the number of payments you have left are less than the length of the plan you are required to file. Most of the time this means having less than 60 payments left. But if you are a below median income debtor, you will only be required to have a 36 month plan. If you have more than 36 months left to pay for your car, but less than 60, you can still generally work it out to pay the vehicle outside of the plan.
You also may avoid paying a secured debt altogether by surrendering the security. If you give them the car, or allow your home to be foreclosed, they will get the home or the car, but you will very seldom owe them anything beyond this. But be cautious with the surrender of a home in the context of an Homeowner’s Association. Unpaid assessments prior to filing are subject to discharge, but any assessments that accrue after the bankruptcy filing date are still your obligation. Also, many people think that once the home sells or is foreclosed, the new owner becomes liable for unpaid assessments. That may be true in some places, but it is not true in Arizona. If you don’t pay HOA dues, they can sue you and get a judgment for these even after your home is sold or foreclosed. One other thing to consider is that you may discharge your personal obligation on HOA assessments that were due before the bankruptcy was filed, but by statute there is still an HOA lien, and the HOA can foreclose the lien. So if you are planning on keeping your home, you will want to pay any assessments in spite of the bankruptcy.
Non-priority Unsecured Debt
The final kind of debt is non-priority unsecured debt. This is mostly your credit cards and medical bills. These creditors are the last ones to get paid.