Bankruptcy: Payments within Classes of Claims

In Chapter Seven liquidation cases, creditor claims are divided into classes and paid according to an order of priority. The highest priority is for domestic support claims, such as child support, then administrative expenses and so forth. When there are claims of equal priority within a particular class and there are not enough funds to pay those claims in full, then the claims are paid on a pro rata basis.

Exception to the Pro Rata Payment Requirement

In a case that has been converted from a Chapter 11, 12 or 13 to a Chapter Seven case, liquidation expenses have priority over reorganization expenses. This exception encourages professionals to work on the converted case. It is important to note here that Chapter 11 trustee fees are not treated as administrative expenses. Instead, they are labeled as estate fees and are entitled to payment pro rata with Chapter Seven administrative expenses.

Property Held as Tenants by the Entireties

The courts have created a second exception to the rule of pro rata distribution. The exception applies to property that is held as "tenants by the entireties." This type of ownership means that each cotenant (owner) owns an undivided interest in the property. Each tenant has equal rights of possession and enjoyment. It is similar to the concept of "community property." The tenants have a right of survivorship, meaning that if one tenant dies, the other tenant has full title. An important aspect of this type of ownership is that the interest of creditors attaches only if both tenants are indebted to the creditor. The tenancy by the entireties is traditionally for married couples and roughly half of the states allow this form ownership.

The exception arises when one of two tenants by the entireties files bankruptcy and claims state exemptions. The exemption is only allowed to the extent that it is more than the claims of creditors holding joint claims against both cotenants. The non-exempt portion of the property is distributed only to the creditors that hold joint claims against the tenants. The creditors who only have a claim against the debtor cotenant are not entitled to share in the property.

Questions for Your Attorney

  • What exactly does pro rata mean?
  • What is the difference between a liquidation expense and a reorganization expense?
  • My wife and I own property that is exempt from claims under our state laws, does this fall within the tenancies by the entireties exception?
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