Most businesses and individuals need to borrow money at some point, whether it's to invest in expansion, hire more workers or buy a home. But when someone borrows money it's with the expectation of making more money in the future to repay the debt. If this doesn't happen, the borrower may face bankruptcy, which will bring up the question of debt claims and how to pay them.
Definition
A debt claim is a claim that a lender makes asserting that a borrower in the process of bankruptcy owes it money. Lenders can be commercial banks, a business's employees and private lenders or governments. In most cases when a borrower faces enough debt to consider bankruptcy, there will be many different types of debt claims. Each debt claim is the lender's attempt to seek repayment from the borrower through the bankruptcy process. The court that handles the case decides which debt claims to honor and which to dismiss.
Significance
Debt claims play an important role when a business files for Chapter 7 or Chapter 11 bankruptcy. Chapter 7, also known as liquidation, allows the court to sell off all of the business's assets to pay off debt claims. Chapter 11 allows the filer to stay in business but outlines a new plan for paying off debt claims in the future. A similar process applies to personal bankruptcy filers, who can choose between Chapter 7 (liquidation) and Chapter 13 (reorganization). In both cases the court uses debt claims as part of the process to determine how much the business or individual owes and what type of payment is affordable going forward.
Order
United States bankruptcy laws require bankrupt businesses and individuals to pay off their debt claims in a specific order. The first claims paid are secured debts, which use some asset as collateral. For example, a bank loan that uses the business's headquarters building or the individual's home as collateral is paid off when the court sells off the property. The next type of debt claim paid off is the administrative cost of bankruptcy, which involves attorney fees and court fees. Finally, the court can pay off debt claims involving back pay and taxes, as well as unsecured debts with no collateral, if there is any money remaining.
Outcome
Not all debt claims receive the same treatment at the end of a bankruptcy case. Some, such as secured debts, end up being paid off in full since they used real property to back the loan. However, the bankruptcy court may choose to discharge other debt claims after liquidating the borrower's assets in Chapter 7 and paying off the secured debts and administrative fees. In these cases, lenders lose the money the borrower owed and their debt claims are never fulfilled. In a Chapter 11 or Chapter 13 bankruptcy the court may require lenders to agree to accept a reduced repayment or wait longer for repayment as the borrower emerges from bankruptcy.
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