Undersecured Claim

A secured debt is a debt that arises out of a loan which has collateral attached. Usually, these collaterals value higher than the loan amount. For example, if you’re looking to get a loan of $1000, the bank expects you to keep collateral worth $2000 or above. They do this to protect themselves from potential defaults on loan repayment.

But sometimes, the value of the collateral may be lesser than the value of the loan. This type of loan is called an undersecured claim. Take the example of automobiles. A person wishes to purchase his dream car on loan and takes a debt of $25,000. He places his new car as collateral for the loan.

As time passes, the car starts depreciating and losing value. In the event the borrower is unable to repay the money borrowed, the bank has the right to seize and sell his collateral. However, due to depreciation, the car’s value will have reduced from $25,000 to $18,000 – making its value much lesser than the value of the loan. If sold, there is no guarantee that the bank will recover the entire $25,000, purely because the value of the collateral is much lesser than the value of the loan borrowed.

Debt recovery for undersecured creditors

An undersecured creditor is a person who has lent money to a borrower and has received an undersecured property as collateral.

The money lent by undersecured creditors is partly secured (to the extent of the value of the collateral) and partly unsecured (to the remaining deficit). This makes debt recovery a challenge. For one, they are completely vulnerable to all claims and fees that are accumulated as a result of filing for bankruptcy.

Secured creditors who meet specific legal requirements are eligible to apply to the Bankruptcy Court for relief when a debtor file for bankruptcy. If granted this relief, these creditors are compensated for all debts that are above and beyond the loan amount. This way, creditors can recover a substantial portion of their loan. This is called post-petition protection.

However, this post-petition protection is limited only to fully-secured and oversecured debt. Undersecured creditors are ineligible for post-petition protection. Instead, they are eligible for adequate protection.

Adequate protection

Undersecured creditors can apply to the Bankruptcy Court for assistance in the event the debtor’s collateral loses value during bankruptcy, thereby preventing them from recovering the debt. In these cases, the creditors will be compensated in the form of an additional lien, periodic cash payments and other forms of relief.

Adequate protection is extremely beneficial to undersecured creditors when the debtor sells the collateral to repay other high-priority debts.