Viewpoint: Secured and Unsecured Claims – What’s the Difference?

By Lyle D. Solomon | June 23, 2021

Understanding the basics of bankruptcy is crucial as it could be your legal lifeline whether you’re drowning in debt or fighting a legal battle to receive debt payments. Though you can petition the court or seek assistance of an attorney, the legal proceeding has more to it whether your claim is for money for a credit card debt, mortgage, or student loan.

Consumers often try to avoid paying off debts by using various bankruptcy laws. Insurers and insurance proceeds become a lucrative proposition when the claimant, either the insured or a third-party claimant, is bankrupt. Insurers and claim adjusters may get involved in disputes among creditors and have to pay defense costs and claims. That is when they may need to go through the secured and unsecured claims.

If you’re interested in learning more, we have you covered here. The article elaborates on bankruptcy basics covering “secured vs. unsecured claims.”

Bankruptcy basics

Bankruptcy is typically about making “claims.” A debtor files a request to discharge liability on the claims, while the collector or creditor seeks payment.

In general terms, a claim of bankruptcy refers to “right to payment.” This claim doesn’t need to be settled, fixed, or undisputed at a time when the debtor files a bankruptcy petition.

Keep in mind that a bankruptcy claim can be unsecured or secured. And this designation changes the treatment and rights differently during the legal process of bankruptcy. As a creditor, you have a right to payment from your debtor and must have in depth understanding of you designation to make sure that your claim receives the treatment it deserves in bankruptcy proceedings.

Here is a primer of the basic rules of secured and unsecured claims in any bankruptcy case:

Secured claims

As mentioned above, a bankruptcy filer owes a major debt amount to creditors when he or she files for bankruptcy. A claim is precisely “the outstanding debt” that a creditor owes to the debtor.While the same goes for a “secured claim”, there is an interesting twist.

“A secured claim is also a form of debt but it is guaranteed by an asset or property.” When an amount is available to make a debt payment, the court sends a notice to give the creditor a deadline. Referred to as a “claim bar,” it mentions the date by which a creditor should submit his proof of debt claims form.This claim holder information provides the following:

  • The debt type and its description.
  • The sum of money owed.
  • Whether the money owned is entitled to any priority treatment (to be paid before other debts).
  • Whether the debt claim is unsecured or secured.

It is important for a creditor to check the box of “security claim” to ensure the debtor has agreed to pay with property—collateral.Put simply, the borrower or debtor puts up an asset or property the lender can sell if he/she fails to pay the debt or defaulted on the agreement.

Generally, secured debt has two common types—car loans and mortgages.A creditor has an ownership interest legally called as “a lien” on the vehicle or property until the debtor pays off his loan. In case the debtor fails to pay what is due, a creditor can either repossess the car or foreclose on the property.

In contrast, if you’re a creditor or lender with an unsecured debt, the right to claim or foreclose property is exempted if your debtor doesn’t live up to you payment terms. It may include examples like medical bills, credit card balance, payday loans, and other personal loans.

This is the reason why most creditors vigilantly submit the debt claim form to avoid forfeiture of the right to receive the available funds.

It is the right of secured creditor to enforce the “lien” to the automatic stay in legal proceeding. A secured creditor often seeks exemption from the automatic stay to sell collateral under certain circumstances.

The debtor has an option to reaffirm or surrender the debt and keep paying the amount.

Unsecured claims

An “unsecured debt” is a claim that’s not secured by any collateral, including lawsuit judgments, medical bills, or credit card debt against creditors. If you’re an unsecured creditor, you don’t have a right to claim property or asset of the debtor to satisfy your debts.

Instead, you can file a lawsuit against borrower and win the case before initiating collection proceedings. If the debtor owns a “nonexempt property or asset“, the trustee possesses, sells, and distributes the proceeds to unsecured creditors.

If the asset is for debt security, the secured creditor gets the payment first.Suppose, you have a debt of $5,000 on your car that is worth $9,000, the car’s holder will get $5,000 and distribute the remaining amount of $4,000 to unsecured creditors.

Remember that holder has to pay unsecured creditors in order for priority debts (the debts repaid first for public policy). These may include spousal support, tax debts money owed to employees, and child support.

When a bankruptcy case is dismissed, a creditor may still owe some unsecured debts. It is because the creditor cannot discharge the debts in bankruptcy that includes student loans, tax debts, and child support.It falls into a category called non dischargeable but court wipe out at the end of the case.

Tools to improve the creditor’s position

It is crucial to keep in mind that creditors are not powerless if a debtor or lender declares bankruptcy. While the process of bankruptcy seems pro-debtor, the creditor may use many tools to protect their interests.

Although not every strategy or tool is accessible to all creditors, and not all of them are effective in each bankruptcy case, creditors must know what rights they have and how they can enforce them.

Take a look at the common tools creditors can use to support their case:

Granting relief from getting an automatic stay.As mentioned above, secured creditors may get relief from automatic stay from the bankruptcy court. It allows creditors to use their state law rights to sell or recover asset securing a debt. The court may grant relief from stay for cause like lack of equity in collateral.However, there can be many other causes.

The administrative freeze. This is another option creditors may use against bankruptcy lawsuit. Most financial institutions and banks impose an administrative freeze on the depository accounts of debtor after learning about bankruptcy. While in many cases holding is a good idea as banks have the authority to set off the money-owed them against the amounts in the debtor’s account, acceptance of the practice may vary district to district. Some bankruptcy courts don’t allow the freeze longer than a week. Other courts consider it a violation of the lawsuit automatic stay.

Set-off. In some bankruptcy cases, the creditor is entitled to set off money owned by borrower against a debt to the debtor. It needs certain substantive and procedural requirements to do this.These may include pre-petition, mutuality, not incurred, and not transferred for set off. Banks and financial institutes typically use set-offs as they owe money to the debtors to the extent of the account with it. The bank is generally a creditor of the debtors to the extent it loans money to them.

Objection to discharge. An action requiring the bankruptcy court to disallow discharge of debtor completely is called an “objection to discharge”. It works to benefit all creditors and includes some fraudulent conveyances recorded within a bankruptcy year in which the debtors tried to destroy or hide assets.

Exception to discharge. When creditors ask the bankruptcy court to accept some debts or money from discharge, it benefits a few of them. An exception to discharge, in contrast allows individual creditors to follow state law right on a particular debt once discharged is entered. It may include, debts obtained via fraud, debts involving malicious and willful injury to the asset, and reaffirmation agreements

A reaffirmation agreement re-obligates a borrower on the debts that have to be discharged.After the court closes the bankruptcy and default case, the creditor collects reaffirmed debt as if there was no bankruptcy.Also, a reaffirmation allows many creditors to take a deficiency judgement in case of any default.

Secured vs. unsecured claim

Essentially, a creditor whose claims are secure is in a better position compared to unsecured creditor. For instance, if a bankruptcy wipes away debt or the money due, it cannot eliminate ownership or a lien on the property of the debtor. The discharge excludes the liability of the debtor.

In legal terms, in a secured transaction, the creditor is granted an ownership on, identifiable, specific property of the debtor, the Uniform Commercial Code’ s Article 9 governs the term of the transactions if the collateral is a property. This lien is referred to as a “security interest.”

In a nutshell, any debts and loans fall under the categories of secured and unsecured debt. This significant divide has an impact on the treatment of an unsecured creditor vs. secured creditor in the legal bankruptcy proceeding.

About Lyle D. Solomon

Solomon is the principal attorney for the Oak View Law Group in Rocklin, California. He been affiliated with the law firms in California, Nevada, and Arizona. He can be reached on Twitter @lyle_solomon.

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