A fully secured creditor is the holder of a claim that is secured by property of a value that equals or exceeds the amount of the claim. An undersecured creditor is the holder of a claim that is secured by property of a value that is less than the amount of the claim.
For example, assume the debtor has a piece of equipment valued at $100,000. The equipment is subject to two liens. The first is an $80,000 first lien and the second is a $50,000 second lien. The holder of the first lien is fully secured since that creditor’s lien ($80,000) is less than the value of the equipment ($100,000) which is may also be known as the “collateral.” The holder of the second lien is undersecured since that creditor’s lien ($50,000) exceeds the remaining value of the equipment ($20,000) after hypothetical satisfaction of the first lien ($100,000 - $80,000 = $20,000).
An undersecured creditor is treated as having two separate claims, one secured and the other unsecured. In our example, the second creditor’s secured claim is $20,000 (the amount of value of the equipment after payment of the first lien holder) and the unsecured claim is $30,000 (the total lien of the second creditor of $50,000, less the $20,000 secured portion of the lien).
However, in a Chapter 11 case, an undersecured creditor may waive its unsecured claim and elect to have its claim treated as being fully secured by exercising what is called a Section 1111(b) election. This election has ramifications beyond the scope of these FAQs.