Which Creditors Are Paid First in a Liquidation?

Liquidation is the process of ending a business and distributing its assets to claimants. It often occurs when a company is insolvent, meaning it cannot pay its obligations when they come due. In Section 507 of the Bankruptcy Code, it states that when a corporation is liquidated, creditors are paid in a particular order: secured creditors, like secured bondholders get first priority. This is followed by unsecured creditors. These are generally suppliers, employees, banks, and stockholders.

Secured bondholders and other secured creditors are paid first because their money is usually guaranteed or "secured" by collateral or a contract.

After secured creditors are paid, unsecured creditors are set to be paid next. The first tier of unsecured creditors are those who are entitled to receive money from the company, but their claims are not secured or guaranteed. This group of creditors includes: bank lenders, employees, the government (unpaid taxes), suppliers and investors who have unsecured bonds.

The last group is the general creditors, which is largely made up of stockholders or shareholders. This set of creditors is paid if there is any money left over after all the other creditors have been paid. The general creditors are divided into creditors who have preferred stock and those who have common stock. Preferred shareholders are paid before those who have common shares. If there is no money after the preferred shareholders are paid, then the common shareholders do not receive any money.

Essentially, unsecured creditors are paid after secured creditors and bondholders because the bondholders have a guarantee from the company. Unsecured creditors are paid before stockholders because stockholders are owners of the company and take greater risk.

(To read more about corporate bankruptcy, please refer to An Overview of Corporate Bankruptcy.)