Who gets paid first in a business bankruptcy?

Federal rules regulate the order in which creditors receive payment when a company is liquidated through a business bankruptcy. That order is generally based on who assumed the most risk when issuing money to the company.

How Are Debt Payments Prioritized During a Business Bankruptcy?

• First priority for debt repayment usually goes to persons who become creditors after the company files for bankruptcy. The purpose of this rule is to enable the company to borrow if necessary to continue its operations and/or to effectively wind down its affairs.
• Secured creditors, such as banks lending money backed by a mortgage on real estate, typically bargained for a lower level of risk. These are the creditors to whom the business owes a debt for something with tangible value. In other words, something measurable “secures” the debt. In a Chapter 11 bankruptcy, secured creditors are paid first, sometimes partially through the return of the property. This is somewhat similar to an individual having his or her car repossessed and sold at auction in an effort to pay down debt.
• General creditors, such as suppliers of goods and services, and other lenders and bondholders, have a greater potential for recovering their losses than stockholders. These creditors loaned money to the business for general use or for intangible things such as credit lines. General creditors are fairly high in priority but not as high as secured creditors. This is true for bondholders as well because bonds represent the debt of the company and the company has agreed to pay bondholders interest and to return their principal.
• Stockholders are last in line. They own the company and take greater risk. Stockholders can make money if a company does well, but they can lose money if the company does poorly. The owners are last in line to be repaid if the company fails.

It’s important to note these are general guidelines established by Sec. 507 of the Bankruptcy Code. The code also includes various exceptions. For example, secured creditors may actually get bumped down in priority if they fail to file their proof of claim.

Case Studies: Debt Payment Prioritization in Business Bankruptcy

Case Study 1: TechTech Corporation

TechTech Corporation, a prominent technology company known for its innovative products, encountered financial difficulties due to a rapid decline in market demand and increased competition. In order to address its financial obligations, the company filed for bankruptcy.

During the bankruptcy proceedings, the creditors were prioritized for debt payment based on the level of risk they assumed when extending credit to TechTech Corporation. Secured creditors, such as major banks and investors who held specific collateral or liens on the company’s valuable assets, were given higher priority in receiving payment from the liquidation of assets.

Case Study 2: FashionGuru Retail Chain

FashionGuru Retail Chain, a nationwide fashion retailer with a strong brand presence, faced significant financial challenges in the wake of changing consumer preferences and the rise of online shopping. As the company struggled to stay afloat, it was forced to declare bankruptcy.

In the bankruptcy process, unsecured creditors, including suppliers, landlords, and service providers, were prioritized for debt payment based on their level of risk assumption. However, secured creditors with specific contractual arrangements and collateral, such as banks with liens on FashionGuru’s valuable inventory, were given priority over unsecured creditors in receiving payment.

Case Study 3: MegaBuild Construction Company

MegaBuild Construction Company, a reputable construction firm known for its large-scale projects, experienced severe financial setbacks due to a combination of factors, including economic downturn and cost overruns. The company had no choice but to file for bankruptcy to address its mounting debts.

During the bankruptcy proceedings, MegaBuild’s assets were liquidated to repay its creditors. Secured creditors, such as banks and suppliers with valid security interests, were given priority in receiving payment from the proceeds of asset liquidation.

Getting Help

Whether you are a creditor or debtor, consulting with a lawyer is imperative if you wish to understand the payment order during the particular bankruptcy in which you are involved.