Can Debtors Prioritize Debts in Bankruptcy?

Typical Scenario:

Debtor borrowed money from a friend or relative and has been paying them back on a monthly basis.  When the debtor files bankruptcy, they may or may not list this debt in the intake.

The problems this issue causes:

1.  If the debtor is filing a Chapter 13, the debtor will be using all of their disposable income to make their Chapter 13 Plan payment.  This means there will be no money left over to pay the friend or relative.

2.  If the personal loan is included in the Chapter 13 Plan, the friend or relative will be notified of the bankruptcy like all the other creditors.  The friend or relative will be required to file a Proof of Claim and they will be treated as an unsecured debt if no collateral was required for the loan.

3.  If the debtor qualifies for a Chapter 7, the personal loan from a friend or relative (which is normally unsecured) will be discharged in bankruptcy.  Although not obligated by law to do so, after the bankruptcy is discharged the debtor can make payment arrangements with this creditor or any other creditor to repay discharged debts.

What happens if the debt is not reported?

First of all, it is unlawful for the attorney, non-attorney or debtor to withhold any debt or asset information from being listed on a bankruptcy petition.  Secondly, the debtors sign a document within the bankruptcy petition that states they have accurately reported every debt they owe.

Thirdly, if the bankruptcy case is a Chapter 13, not providing for the debt will not provide any money to pay it.  This is because all disposable income is disbursed to paying the creditors.  If the creditor (friend or relative who loaned the debtor money) is not listed in the petition, there will be no money to pay them.

Can the personal debt be reaffirmed?

If a debt is unsecure, a Reaffirmation Agreement is worthless.  Suppose I borrowed $500 from you and said I would repay you.  What happens if I do not pay?  Unless I gave you an asset that you could repossess, there is nothing you can do except file a lawsuit and hopefully win a judgment, which may or may not be collectable.

Therefore, if the debtors sign a Reaffirmation Agreement on an unsecure debt, but they do not honor their agreement; there is no asset that can be taken.  Signing a Reaffirmation Agreement on the debt owed to the friend or relative will do absolutely nothing to the priority of the debt or help to assure the debt is paid differently from the other debts in the same class.

Can the debtor prioritize the debt?

Absolutely not.  Only the bankruptcy court can make the determination of the priority of debts.  If the debtors want to pay back their friend 100% of the money they loaned them but only offer the credit card companies 25% in the Chapter 13 Plan, do you think the credit card companies may be a little upset?  Of course they would, and the attorney can count on an Objection to the Chapter 13 Plan being filed against them.  This delays confirmation as well as creating more work for the attorney.

But this scenario happens quite often.

If this situation happens to you, do not think it is rare.  Every bankruptcy attorney has encountered this same scenario and it much more common than you may think.   In fact, I remember encountering these same problems back in the early 1980s.  It is common for debtors to borrow money from family and friends prior to filing bankruptcy.  Of course most of them feel obligated to pay back the family or friend, which is also morally correct.  However, placing a creditor as priority above another creditor is considered an act of fraud and is never to be offered as an option for the debtor.

Suggestion for attorneys when faced with this situation.

Be honest and tell the debtor what may or may not happen concerning the debt owed to their friend or relative.  As provided for above, treatment of the debt will vary depending on whether the debtor is filing a Chapter 7 or a Chapter 13.

Also, remember to point out the positive points of the Chapter 13 Plan. For the attorneys that I prepare petitions for, I give them a summation that they can share with the debtor.  For example:

1.   2008 Toyota RAV4 crammed down from $28,078.97 to the market value of $16,375.00; thus saving the debtors $11,073.97.

2.   Interest rate on 2008 Toyota RAV4 was reduced from 14.5% to 2.0%.

3.   Due to the reduction in the amount owed on the 2008 Toyota RAV4, the monthly payment was kept the same but the length of the loan was reduced from 59 months to 35 months; thus paying the car off earlier.

4.    The televisions sets were proposed as EXEMPT since they are household items. Therefore, the payment of this debt was removed from the Chapter 13 Plan.  If the creditor does not object, the debtors will NOT have to repay the $4,200.00.

5.  Plan Summary:
Monthly payments: $643.00
Length of payments:  60 months
Unsecured Plan Percentage: 38%

Do you need assistance with your Chapter 13s?

If you are an attorney seeking attorney-quality work for preparing your Chapter 13 bankruptcy petitions, consider the virtual paralegal services of Victoria Ring and Michael Misenheimer.  For more information visit

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