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Secured versus Unsecured Creditors

January 6, 2013

At first glance, bankruptcy may seem like a fight between a debtor and his creditors. The reality, however, is often more complicated. A debtor’s bankruptcy frequently gives rise to fights among creditors, too.


Why are creditors fighting amongst themselves? In situations in which there are more mouths to feed than food to distribute, creditors will clamor in court to receive a greater percentage of the debtor’s assets. Ultimately, the distribution of a debtor’s assets is determined by the Bankruptcy Code’s priority scheme.


So, which creditors win and which lose – and why? Although there are a number of fine divisions between types of creditors, the single greatest separation is whether a creditor is secured or unsecured. Secured creditors are those who have an attached, enforceable security interest in the debtor’s property.


In some cases, a creditor may successfully establish a secured interest by taking possession of the underlying collateral. Possession may be actual, such as driving the car from in front of your house. Possession may also be constructive, such as acquiring the key to a house.


More commonly, a creditor will establish a secured interest by acquiring a contract with the debtor that outlines the terms of a financial arrangement and subsequently filing that contract with a state registration office. In this manner, both the debtor and other creditors are on notice that the debtor’s assets are not entirely his own, but the creditor’s.


However securitization occurs, the bottom line is that secured creditors will often receive the value of the underlying collateral in the event of bankruptcy rather than the unsecured creditors’ lot: a pro rata distribution of the debtor’s available assets. Frequently, the difference between specified collateral and the pro rata remainder is significant.

Do you have questions about what kind of interests your creditors hold in your property – and whether their status might give you leverage as you consider your financial obligations? The attorneys at Fears Nachawati are prepared to help you answer these and many more questions. Find out how we can help you by contacting us today.


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