A deficiency claim is a type of unsecured claim in bankruptcy that is the difference between the value of a secured claim and the amount that the underlying collateral is able to satisfy.
When a debtor defaults on a secured loan, such as a mortgage or car loan, the lender has the right to seize and sell the collateral (the house, car, etc.) to satisfy the debt. If the sale of the collateral does not cover the full amount of the debt, the remaining amount is called a deficiency.
In a bankruptcy proceeding, this deficiency becomes an unsecured claim. The lender, now a creditor in the bankruptcy, can file a deficiency claim for the remaining balance. However, deficiency claims often receive less favorable treatment compared to the original secured claim because they are now considered unsecured debt. They are typically paid out only after all secured claims and priority unsecured claims have been satisfied, and only if there are sufficient assets remaining.
For example, let’s say a person has a mortgage with a balance of $200,000 but goes into bankruptcy and the house is sold for only $150,000. The remaining $50,000 ($200,000 – $150,000) is the deficiency. The mortgage lender can file a deficiency claim in the bankruptcy for this amount.
However, whether a deficiency claim can be made and how it is treated can depend on the specific bankruptcy laws in the jurisdiction, the terms of the original loan agreement, and the specifics of the bankruptcy case. In some cases, certain jurisdictions or loan agreements may not allow for deficiency claims.
Example of a Deficiency Claim
Let’s illustrate a deficiency claim through a real-world example:
John owns a car that he bought with a loan from Bank A. The outstanding balance on the car loan is $20,000. However, John runs into financial difficulties and files for bankruptcy.
As part of the bankruptcy proceedings, John’s car is seized and sold to help repay his debts. The car is sold for $15,000, which is paid to Bank A.
In this case, the proceeds from the sale of the car do not fully cover the amount John owes to Bank A. The remaining $5,000 ($20,000 – $15,000) that John still owes is the deficiency.
Bank A, as the creditor, can file a deficiency claim in John’s bankruptcy for the $5,000 that was not covered by the sale of the car. This deficiency claim is now considered an unsecured debt.
In the subsequent bankruptcy proceedings, this deficiency claim will be lumped with John’s other unsecured debts. If there are sufficient assets remaining after paying off all secured and priority unsecured claims, Bank A may receive a portion of the $5,000 deficiency. However, in many bankruptcies, there are not enough assets to fully satisfy all unsecured claims, so Bank A may only receive a fraction of the $5,000 or potentially nothing at all.
Again, it’s important to note that the ability to file a deficiency claim and how it’s treated can vary based on jurisdiction, the terms of the original loan, and the details of the bankruptcy case.