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Creditors in Bankruptcy: What Are the Different Types and Why Does It Matter
by Adam Mack, J.D.
Creditors are simply anyone to whom you owe money. They could be mortgage lenders, banks or credit unions, credit card companies, utility companies, the government,family members, even your local library. When evaluating whether filing bankruptcy is a good option for your situation, it's important to look at what types of creditors you have. There's more than one type of filing and determining which one is the best fit will include looking at the type of debt as much as the amount. Someone who doesn't have any secured creditors will likely need very different options than someone who is behind on a mortgage and wants to keep his or her home.
What is a Secured Creditor and why does it matter?
"Security" in terms of financial transactions is an asset you used to back up your promise to repay money you owe. Perhaps the most common example of this is when you buy a car on credit. The car itself becomes "security." As long as you're keeping your end of the contract, you get to keep the car; however, if you are unable to make payments, the bank can repossess it. So a "secured creditor" is one who is able to repossess or foreclose on an asset if you break the loan agreement, or in other words, a secured creditor can repossess the security. The most common types of secured loan contracts include loans for real estate (like a home mortgage), cars and other vehicles (including boats, etc.), furniture, and some electronics.
During a successful bankruptcy, there are several potential outcomes for any given debt. For secured loans, the two most common outcomes are discharge or reaffirmation. If you surrender the security (for example, give your boat back to the bank that loaned you the money to buy it), then the debt can be discharged, essentially meaning that your obligation to pay that debt is wiped out after the creditor is paid out of the bankruptcy estate. But if you want to keep your security (for instance, if you want to keep your house) and if you can afford to keep making payments on that particular loan, you can sometimes "reaffirm" the debt.
"Reaffirmation" is actually something of a misnomer. If you file, almost all of your debts are going to be presumed as being discharged. At that point, your personal obligation to pay that secured debts is wiped out (note that this does not mean you can keep the property while not paying for it). A reaffirmation agreement brings that personal obligation back to life and is essentially a new agreement to be personally liable to pay the debt. Because it's a new loan that has to be independently negotiated between you and your lender, there are several factors that the court considers when deciding whether to allow you to reaffirm a debt. Evaluating whether you can or should reaffirm a debt should be done by consulting with an attorney. As with virtually every other aspect of filing, there are benefits and pitfalls to reaffirming your debt, but a qualified attorney can help guide you make the choices that will be best for your specific case.
What is a Priority Creditor and why does it matter?
Priority creditors are those whose loans to you are legally considered more important (or "higher priority") than your other debts. Most commonly, priority debts include tax debts, domestic support arrears like child support or maintenance (aka alimony), wages you might owe to employees if you're a business owner, etc. Essentially, a priority debt is one you owe to the government or a debt in which someone else's well-being and livelihood depends on you repaying it. Priority debts are defined in the bankruptcy code.
The biggest difference between priority creditors and your other lenders is that priority debts can rarely be discharged. So while your obligations to pay your credit card debts can be wiped out and you can return your boat to the bank to have that loan discharged, you'll still need to pay child support arrears or most types of back taxes. What's more, when a bankruptcy estate is being divided up among the various lenders, priority debts get a larger slice of the proverbial pie. So for example, if you owed a tax debt, that debt wouldn't get discharged (so you'd have to keep paying on it).
Sometimes people will use the terms "non-dischargeable debts" and "priority debts" interchangeably, though that's not entirely accurate. While many priority debts are non-dischargeable, some debts that are not considered priority are still non-dischargeable. The most common example of a typically non-dischargeable non-priority debt is a student loan.
What is an Unsecured Creditor and why does it matter?
Simply put, unsecured creditors are all the ones who don't fit into one of the two categories above. The majority of your creditors will likely be unsecured, and the most common types of unsecured debts are credit cards, most medical bills, many judgments against you from small claims or other courts, as well as debts owed to public utilities, and friends and family.
Generally speaking, unsecured creditors get their legally-permitted share of the bankruptcy estate and the rest of the debt you owe to them is discharged. Fortunately, the vast majority of the creditors in an average bankruptcy are unsecured, meaning that once the process is complete, your obligation to pay that debt will be gone for good and you'll never have to worry about it again. That kind of peace of mind is our goal for you as bankruptcy attorneys.
The Most Important Part
If you decide that bankruptcy is the best choice for you, a qualified attorney can review your financial situation, discuss with you which assets you want to and can afford to keep, and can help you determine which type will work best. Remember, the purpose of bankruptcy is two-fold: to give you a fresh start and to make sure your creditors get their fair share. Most of your creditors will have attorneys to make sure they're getting everything they can; you deserve a good attorney to make sure your rights are protected, too.