Claims in bankruptcy: Overview, definition, and example
What are claims in bankruptcy?
Claims in bankruptcy refer to the debts or obligations that a debtor owes to creditors when they file for bankruptcy. These claims represent the amounts that creditors are entitled to receive as part of the bankruptcy process, typically through a court-managed procedure designed to settle the outstanding debts. Claims in bankruptcy can be classified into different categories, such as secured, unsecured, priority, or non-priority claims, depending on the nature of the debt and the creditor’s legal rights.
For example, a creditor with a secured claim has a right to specific property or collateral in the event of bankruptcy, while a creditor with an unsecured claim does not have such security.
Why are claims in bankruptcy important?
Claims in bankruptcy are important because they determine how the debtor’s available assets will be distributed among creditors. The classification of claims—secured versus unsecured, priority versus non-priority—establishes the order in which creditors will be paid. Secured creditors typically have the highest priority, followed by priority unsecured creditors (such as employees or tax authorities), and then general unsecured creditors. This hierarchy helps the court fairly allocate the debtor’s remaining assets and provides transparency to both the debtor and creditors.
For businesses and individuals facing bankruptcy, understanding the classification of claims is crucial for determining how much they might recover from the bankruptcy proceedings. For creditors, it helps them understand their position in the process and the likelihood of being paid.
Understanding claims in bankruptcy through an example
Imagine a business, XYZ Corp., files for Chapter 11 bankruptcy. The business owes $5 million in total debts, including $2 million in secured loans (with collateral), $1 million in unpaid employee wages, and $2 million in unsecured credit card debt. In the bankruptcy process, claims will be categorized and prioritized as follows:
- The secured creditors (those holding the $2 million loan) will have the first claim on XYZ Corp.'s assets, which may include real estate or equipment.
- The priority unsecured creditors (the $1 million in unpaid employee wages) will be paid next, as employee wages are generally given priority under bankruptcy law.
- Finally, the unsecured creditors (the $2 million in credit card debt) will receive any remaining funds after secured and priority claims have been settled, but they are likely to receive only a fraction of what is owed, depending on the amount of remaining assets.
An example of claims in bankruptcy clause
Here’s how a claims in bankruptcy clause might appear in a contract:
“In the event of a bankruptcy filing by either party, the claims of creditors shall be classified as secured, unsecured, or priority claims in accordance with applicable bankruptcy law. Secured creditors shall have the first right to the collateral, followed by priority claims as specified by law, with general unsecured claims being satisfied last, subject to the availability of funds after the above claims have been paid.”
Conclusion
Claims in bankruptcy refer to the debts owed by a debtor to various creditors during a bankruptcy proceeding. These claims are classified into categories like secured, unsecured, and priority claims, and the order of payment is determined by the nature of the debt and applicable bankruptcy laws. For both creditors and debtors, understanding the classification of claims is essential for navigating the bankruptcy process and determining how assets will be distributed. Claims in bankruptcy play a key role in ensuring a fair and transparent resolution of debts, with the aim of allowing the debtor to restructure or liquidate while addressing outstanding obligations.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.