Question

Not all debt has the same priority in the event of a bankruptcy. Discuss the three categories of debt priority.

Answer 1

In the case of bankruptcy, debts are being classified as secured, unsecured and priority debts. The different classifications are based on the type of claim the creditor can make on the debt.

Secured Loans: These are debts which have been secured against a collateral and is mostly common in case of house loan or car loan. In this type of claim the creditors have the benefit of enforcing the lien on the debt in case of bankruptcy filed by the customer. For example: in case of car loan , the car is considered to be a lien with the creditor and when a customer defaults, the creditor has the benefit of claiming its debt against this car. These debts are applicable to organizations also and are available on the balance sheet of a company. As discussed, they have a lien attached to the debt and hence needs to be repaid in case of bankruptcy or the creditor has the right to cease the collateral attached.

Unsecured loan: These are debts which are not secured against any collateral and is the most common form of debt. Any debt such as credit card, medical bills, loans without any collateral are considered to be unsecured debt. These are the last kind of debt being paid in case of any asset distribution of a firm which has been considered bankrupt. These are thus, considered to be the least priority debt on a company's balance sheet.

Priority debt: Priority debt on the other hand is the most important debt amongst all the three and as the name suggest needs first priority in case of any bankruptcy. These debts include child and spouse support such as alimony, any tax obligations and salaries owed to the employees. These debts cannot be discharged and is supposed to be cleared first from the company's balance sheet at the time of bankruptcy.