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How Much Are Unsecured Creditors Paid in Chapter 11?

The Law Offices of David K. Blazek, P.C. April 17, 2024

Man with coins in hand carrying chapter 11 bankruptcy fileBankruptcy can be a distressing legal process, particularly if you're an unsecured creditor—someone owed money without collateral attached to the debt. Whether you’re a debtor or a creditor in the context of a Chapter 11 bankruptcy case, it's good to understand how the process works and how unsecured creditors get paid. 

General unsecured claims (unsecured lines of credit, business credit cards, and similar debt) rank the lowest in priority for repayment under Chapter 11 bankruptcy, meaning the creditors in this category are likely to receive the smallest payouts.  

But unsecured claims for domestic support obligations (e.g., child support, alimony) are prioritized above all else. So even if the debtor files for bankruptcy protection, these must still be paid.  

Basically, in Chapter 11 proceedings, not all unsecured creditors are created equal: non-priority unsecured claims may receive only cents on the dollar while priority claims could collect close to full value—though typically over an extended payout timeline. 

In other words, while some unsecured creditors may still receive a substantial portion, others might be left with minimal repayment or, in some cases, nothing at all. The averages can vary widely, influenced by a variety of factors and the specific circumstances surrounding each bankruptcy case. 

Understanding Chapter 11 Bankruptcy

In the United States, Chapter 11 of the Bankruptcy Code generally applies to businesses that wish to restructure their debts to keep their doors open and pursue profitable operations. For individuals, Chapter 11 may come into play if they exceed the debt limits of Chapter 13 (used for personal bankruptcy) and often involves crafting a plan to repay creditors over time, typically slashing debts and obligations to balance against income. 

The primary goal of Chapter 11 is to provide an orderly way for a business to pay off its obligations while continuing or halting operations.  

During the process, the debtor in possession—the entity that's filed for Chapter 11—maintains control of its assets and continues to operate under the oversight of the bankruptcy court.  

For an unsecured creditor, this means the court-approved reorganization plan will outline how its debts will be paid, if at all, and the timing of such payments. It's critical for creditors to follow the bankruptcy court's instructions closely to ensure they receive any payments due. 

The Repayment Hierarchy in Chapter 11

Within the framework of bankruptcy, there's a hierarchy dictating which creditors get paid first. This priority system can directly impact unsecured creditors' potential recoveries.  

The Bankruptcy Code under 11 U.S.C. §507 prioritizes debt into categories and at the bottom are general unsecured claims, which can be paid a small percentage of their claims. 

Generally speaking, the most important of these is "secured debts" which are loans backed by collateral, like a mortgage or auto loan. If a debtor defaults and files for bankruptcy, the collateral that secures the debt is usually turned over to the creditor, though there are exceptions and nuances. 

At the bottom of the priority list are "general unsecured claims," like unsecured lines of credit, business credit cards, and other similar debts. Being last in line, general unsecured creditors typically receive the lowest payments in a Chapter 11 bankruptcy. 

Here's a comprehensive list, ranked in order of priority:  

  1. Obligations for domestic support

  1. Administrative expenses

  1. Unsecured claims are permitted in an involuntary case after initiation but prior to the Order for Relief and Trustee appointment

  1. Permissible unsecured claims for specific wages, salaries, or commissions

  1. Defined claims for contributions to an employee benefit plan

  1. Unsecured claims against farmers and fishermen

  1. Unsecured claims, up to $1,800, arising from money deposits related to the purchase, lease, or rental of property, or the acquisition of services, for the personal, family, or household use of such individuals, that were undelivered or unprovided 

  1. Permitted unsecured claims of governmental units

  1. Approved unsecured claims based on any commitment to a Federal regulatory agency for depository institutions to maintain the capital of an insured depository institution 

  1. Permitted claims for death or personal injury resulting from the operation of a motor vehicle or vessel if the operation was illegal due to the debtor being intoxicated from alcohol, a drug, or another substance

The Absolute Priority Rule

For unsecured creditors, a Chapter 11 plan is fair and just if the creditor gets paid what they're owed, and higher priority creditors or equity owners don't get anything. This is known as the "absolute priority rule." 

In simpler terms, if a secured creditor is treated well in the plan, general unsecured creditors must be paid in full or get nothing.  

Similarly, if the company owners want to keep their ownership stake, they must pay off all general unsecured creditors first. The rule also applies in individual Chapter 11 cases when individuals want to keep their exempt property but affect general unsecured creditors. 

If a Chapter 11 plan can't be approved, the Court can dismiss the case or switch it to Chapter 7, leading to business closure. 

How to Overcome the Absolute Priority Rule

There are ways to work around the absolute priority rule in Chapter 11 bankruptcy. One common method is the "New Value Exception," allowing shareholders to keep their equity by injecting new value into the company after a market valuation.  

In a Chapter 11 plan for a small business, all ownership interests are canceled upon confirmation, followed by a public auction for 100% ownership in the reorganized company.  

Another approach is the "gifting doctrine," where a secured creditor gifts funds to unsecured creditors to facilitate plan confirmation. The rule doesn't apply if an impaired class supports the plan, and unsecured creditors can be divided into fair classes.  

Contact a Bankruptcy Lawyer for Guidance

Dealing with unsecured creditors in Chapter 11 can be complicated. The best step you can take to ensure your rights are protected when declaring bankruptcy is to find knowledgeable legal representation.  

For businesses facing financial turmoil, securing the services of an experienced bankruptcy attorney can be the difference between successful reorganization and outright closure.  

Creditors, too, need legal expertise to decipher their rights and to ensure they are adequately represented in bankruptcy proceedings.  

A competent bankruptcy attorney can guide you through the process, advise you on your options, and help you determine the best strategy for pursuing a satisfactory recovery. 

For assistance with Chapter 11, reach out to The Law Offices of David K. Blazek, P.C. The firm has Florida offices in Tampa and Boca Raton and a Georgia location in Atlanta. Their bankruptcy attorney serves clients throughout Miami, Jacksonville, Orlando, Macon, and Columbus.