Preferred Creditors Explained: Who Gets Paid First in Bankruptcy?

Understanding Preferred Creditors in Bankruptcy

A preferred creditor, sometimes called a preferential creditor, is an individual or organization that holds priority when it comes to receiving payment if a debtor files for bankruptcy. This priority status means they are among the first to be repaid from the debtor's available assets.

Key Insights

• Preferred creditors have precedence over other creditors during bankruptcy proceedings.
• Legal definitions of preferred creditors vary by country and jurisdiction.
• Common preferred creditors include employees owed wages and government tax authorities.
• Bankruptcy does not absolve debtors from paying their debts; it prioritizes payment distribution.
• Preferred bondholders often have a higher likelihood of recovering owed funds.

How Preferred Creditors Work

When a company or individual becomes bankrupt, their available funds are usually insufficient to cover all debts. Preferred creditors are prioritized by law to receive payment before other creditors. This hierarchy ensures certain obligations, like employee wages and taxes, are addressed first.

In many legal systems, preferred creditors include bondholders with preferential status and, in some cases, tax authorities. Additionally, economic development institutions, such as the World Bank, may have priority claims on loans to countries facing financial crises, even if not explicitly stated in contracts.

Important Note

Preferred creditor claims might be paid in full or up to a specified percentage depending on the case.

Categories of Preferred Creditors

Preferred creditors come in various forms, each with specific claims prioritized by law:

• Employees: Workers owed unpaid wages are typically the highest-priority creditors.
• Tax Authorities: Government bodies like the IRS in the U.S. or HMRC in the U.K. are entitled to recover owed taxes after employee claims.
• Environmental Remediation: Costs related to cleaning environmental damage caused by bankrupt businesses may receive preferential treatment.
• Tort Victims: Individuals harmed by the bankrupt entity’s actions may be granted preferred creditor status as involuntary creditors.

Notable Update

As of December 2020, the U.K.’s HMRC regained preferred creditor status after 18 years of being treated as an unsecured creditor with limited recovery prospects during company liquidations.

Preferred Creditors vs. Unsecured Creditors

Unsecured creditors lend money without collateral, divided into priority and general unsecured creditors. Priority unsecured creditors rank above general unsecured creditors but usually below preferred creditors in bankruptcy payment order.

In the U.S., creditor payment hierarchy typically follows this order:

1. Secured claims
2. Administrative expenses and priority claims
3. General unsecured claims
4. Subordinated claims
5. Equity interests

In the U.K., the order is:

1. Fixed charge holders
2. Liquidators’ fees and expenses
3. Preferred creditors
4. Floating charge holders
5. Unsecured creditors
6. Interest on unsecured debts post-liquidation
7. Shareholders

Additional Considerations

Preferred creditors generally outrank unsecured creditors. However, in some jurisdictions, preferred creditors may be prioritized over floating charge holders but subordinate to fixed charge holders, such as banks holding business asset titles.

Summary of Differences

Preferred creditors receive payment priority during bankruptcy, while unsecured creditors face a lower likelihood of repayment.

Who Qualifies as a Preferred Creditor?

Employees owed wages, tax authorities, environmental remediation claimants, and tort victims typically qualify as preferred creditors.

Will Employees Be Paid If Their Employer Files Bankruptcy?

If your employer declares bankruptcy, employees owed wages are considered preferred creditors and are prioritized in the distribution of available funds.

Discover engaging topics and analytical content in Corporate Finance as of 29-04-2022. The article titled " Preferred Creditors Explained: Who Gets Paid First in Bankruptcy? " provides new insights and practical guidance in the Corporate Finance field. Each topic is meticulously analyzed to deliver actionable information to readers.

The topic " Preferred Creditors Explained: Who Gets Paid First in Bankruptcy? " helps you make smarter decisions within the Corporate Finance category. All topics on our website are unique and offer valuable content for our audience.