What is a Priority Creditor - Part 2

Last week, I wrote about priority debt - the type of unsecured debt that Congress decides should take priority over general unsecured debt in a bankruptcy case. Holding priority debt can be very beneficial for creditors, since in a chapter 7 case, all priority debt is paid, in full (if there are sufficient funds available) before any general unsecured debt is paid, and in a chapter 13 case, all priority debt must be paid in full in order for a chapter 13 plan to get confirmed and for the chapter 13 debtor to receive a discharge.

Deposits

In seventh position among priority creditors are individuals who have paid a deposit to a bankruptcy debtor “of money in connection with the purchase, lease, or rental of property, or the purchase of services, for the personal, family or household use of such individuals.”

This priority claim affects bankruptcy debtors who operate businesses and/or lease property to third parties. The priority exists so that people in business are discouraged from using deposits paid by customers or tenants for personal or business expenses. There are limitations to the priority: as noted in the paragraph above, the deposit must be for property or services used for personal, family or household purposes of the depositor. So the rent/security deposit paid by an individual for a commercial rental would not be a priority debt. And there is a dollar limit to the priority: the priority amount is $2850 or less. Any deposit over and above that amount is a general unsecured debt.

Keep in mind that deposits can be made for something other than real property - although the un-refunded deposit paid by tenants to a landlord/property owner/bankruptcy debtor is the most common scenario. Deposits can also be paid to craftsmen for work to be done in the future, or to professionals for services not yet performed. These types of deposits fall within the definition of a priority debt.

Taxes

In eighth place among priority debt is tax debt. The definition of what type of tax debt qualifies for priority treatment is quite involved. Here’s what the bankruptcy code says qualifies a tax liability as a priority debt:

The tax must be a claim of a “governmental unit.” Included are income taxes. But the income tax liability has to meet certain criteria to be qualified as a priority debt. First, the income tax liability must be for a return that was due less than three years before the bankruptcy case was filed. Second, the income tax liability must have been assessed more than 240 days before the bankruptcy case is filed. However, the 240-day period doesn’t run during any time that the taxpayer/bankruptcy debtor had an offer in compromise pending with the taxing authority, plus 30 days. Third, the 240-day period doesn’t run during any time that taxing authority has formally stayed the collection of the tax (when taxpayers ask the taxing authority to create a monthly repayment schedule, for instance, the taxing authority will often stay collection of taxes), plus 90 days. Fourth, a tax liability cannot be a priority debt if the liability was assessable prior to the bankruptcy case being filed, but had not yet been assessed at the time the bankruptcy case was filed.

Property taxes are a priority tax obligation. The limitation on property taxes as a priority debt is that the property tax must have been due at the time the bankruptcy case was filed and that the property tax is relatively new: in order to be a priority debt, the property tax liability must be recent enough that there is still a year to go before any penalty attaches to the property tax payment at the time the bankruptcy case is filed.

Sales taxes are a priority debt. There’s no limitation to this; if a bankruptcy debtor is personally liable for payment of sales tax, that tax debt is a priority.

Withholding taxes are a priority debt. As is the case with sales tax, it doesn’t matter how old the tax obligation is; if a bankruptcy debtor is required to withhold taxes from employees' paychecks, that unpaid obligation is a priority debt.

Excise and use taxes are priority debts, provided the taxable event took place before the bankruptcy case was filed.

Customs duties are priority debts. The limitation on this priority is that the duty must have been in place for one year or less prior to the bankruptcy case filing.

Federal Deposit Obligations

In ninth position among priorities are debts that are owed by banks or other lending institutions to “maintain the capital” of an “insured depository institution.” In other words, banks must maintain enough money on hand to satisfy federal regulations regarding the capitalization of banks, so that if there is a “run” on a bank, there are sufficient funds available to satisfy depositors' demands to withdraw funds. There’s no limit on this priority. The priority is in place to protect small account holders with banks and to discourage banks from not maintaining sufficient capital.

Impaired Operation Debt

In tenth, and last place among priorities are debts that arise out of the operation of a motor vehicle or a vessel, that results in personal injury or death, provided that the operation of the vehicle was illegal due to the intoxication of the debtor due to the use of alcohol, drugs, or “another substance.” The language describing this last priority mirrors the language of section 523 of the bankruptcy code, which provides that this type of debt is not dischargeable. So why have this listed as a priority debt? The answer is that Congress intended to maximize the ability of victims of impaired drivers to recover damages from the operator/bankruptcy debtor in situations where, after insurance (if there is insurance) has been exhausted, the victim has a chance to receive additional recovery from the debtor’s assets, particularly since the bankruptcy debtor in this situation is often going to face incarceration in the near future.

Priorities go in Order

Remember a couple of things: first, simply because a type of debt has priority status doesn’t mean the debt can’t be discharged in a bankruptcy case. Check with one of the attorneys at Kain and Scott to make sure you are aware of what priority debts can and cannot be discharged in bankruptcy.

Second, priority debt gets paid in order, and the superior priority creditor gets paid in full before the next priority creditor gets paid at all.

That’s the world of priority debt - remember, consult with one of the attorneys at Kain and Scott if you have this kind of debt to make sure you know how the debt will be handled in a bankruptcy case.