One of the most important aspects of bankruptcy is that all debts are not equal. “Priority” debts are treated special in a number of ways.
Debts Are Different So the Law Recognizes Some Differences
The law does not treat all debts the same. That’s because you have different kinds of creditors that you owe for very different reasons. The law tries to be practical and so to some extent it respects these differences.
Your debts all fall into three categories:
Today we start a series of blog posts covering priority debts.
Priority debts are specific categories of debts that the law has decided should be treated as more important. Bankruptcy gives them higher priority, especially over “general unsecured” debts. Priority debts have power over you and over other debts in various ways.
Secured debts that are debts with liens on something you own. Secured debts are special in that the creditor usually has a stronger position because of its lien. The lien gives the creditor power over you if you want to keep whatever secures the debt.
Most priority debts are unsecured, but some may have a lien and so are secured. Secured priority debts have that much more power over you and over other creditors.
Reasons for Priority
Each of the priority debt categories have their own different reason to be treated as special.
For example, the two most common categories of priority debts in consumer bankruptcy cases are:
Child and spousal support—the support you would owe when filing your bankruptcy case. See Section 507(a)(1) of the U.S. Bankruptcy Code.
Income taxes—certain income taxes that meet certain conditions. See Section 507(a)(8).
Support payments are special essentially because society very strongly believes that children and ex-spouses should receive the financial support ordered by divorce courts. Federal bankruptcy law incorporates this social attitude. So support debt has the highest priority in the list of priority debts.
Income tax debts are special because taxes are a debt to the public at large. It’s not a debt to a private person or business. In effect it’s a debt to us all. So it deserves a higher priority than regular private debt. However, unlike support debt which is always a priority debt, an income tax is a priority debt only if it meets certain conditions. Those conditions mostly relate to how old the taxes are. The newer the tax is the more likely it is to be priority. Income taxes that do not meet the required legal conditions are mere general unsecured debts.
Priority Debts in Bankruptcy
In most bankruptcy cases there isn’t enough money to pay all debts. So the laws that determine the order that creditors get paid often determine which debts receive full or partial payment and which receive nothing. Priority debts often receive full payment while general unsecured debts receive less or, often, nothing.
This works very differently under Chapter 7 “straight bankruptcy” vs. Chapter 13 “adjustment of debts.” Our next blog posts will show how.