If your business is considering bankruptcy—particularly Chapter 11 bankruptcy—you may be wondering what will happen to your creditors. A common question during this process is, who gets paid first in a Chapter 11 bankruptcy? At Bruner Wright, we have helped many companies successfully navigate the complex landscape of bankruptcy and restructuring. While each case is unique, we can provide insight into how the repayment process typically works and how it may affect your business.
How Will Your Creditors Be Paid?
During a Chapter 11 bankruptcy, creditors are generally paid in a specific order of priority. This payment hierarchy is critical for businesses to understand, as it can influence how resources are allocated and which debts are addressed first. Knowing who gets paid first in a Chapter 11 is essential for business owners as they work with their legal team to create a restructuring plan.
While exceptions do exist, creditors are usually grouped into categories, with each group being paid according to the priority outlined by bankruptcy laws. Here’s an overview of how different creditors are typically prioritized:
1. Secured Creditors
Secured creditors are at the top of the repayment hierarchy. These creditors, such as banks and financial institutions, have extended loans that are backed by collateral—assets owned by your business. Collateral can include property, equipment, or other assets that secure the loan.
Since secured creditors hold a lien on specific assets, they have a legal right to be repaid from the value of those assets if your business defaults on the loan. For example, if your business took out a loan to purchase equipment, the lender could repossess or liquidate that equipment to recover their funds. The priority of these secured debts explains why they are paid first in a Chapter 11 bankruptcy.
2. Unsecured Creditors
After secured creditors have been paid, the next group in line is the unsecured creditors. These include bondholders, suppliers, vendors, and any other entities that have extended credit to your business without requiring collateral. Unsecured creditors are more vulnerable in a Chapter 11 bankruptcy, as there’s no guarantee they will receive full repayment. In fact, many unsecured creditors may only receive a fraction of what they are owed.
Because unsecured creditors do not have claims on specific assets, their claims are addressed after secured creditors in the repayment process. This order of payment is key to understanding why unsecured creditors often receive less or partial repayment. Nonetheless, unsecured creditors still play a significant role in the Chapter 11 process, as they may vote on the proposed repayment plan. This can affect the outcome of the restructuring process and the business’s long-term success.
3. Stockholders
Stockholders are usually the last to receive any repayment during a bankruptcy. In most cases, stockholders are seen as investors who took on risk when they purchased shares in the business. Since they are not owed a specific amount like creditors, stockholders are typically paid only after all other debts have been settled. In some cases, stockholders may not receive any repayment, especially if the company’s assets have been exhausted by secured and unsecured creditors.
This positioning at the bottom of the repayment ladder is logical, as stockholders are part owners of the business, and their investments were never guaranteed a return. During a Chapter 11 bankruptcy, stockholders must recognize that they are unlikely to recoup their investment unless the business emerges from bankruptcy successfully.
Can You Pay Your Creditors Before Filing for Bankruptcy?
Many business owners wonder if they can preemptively pay certain creditors before filing for bankruptcy, especially if they have personal ties to those creditors. For example, some may choose to pay off loans to family members or friends before officially declaring bankruptcy. While this might seem like a way to prioritize personal relationships, it’s important to understand that these payments can trigger legal consequences.
Under bankruptcy law, payments made to creditors within 90 days of filing for bankruptcy may be scrutinized by the court. If these payments exceed $600 and are made to close relatives or friends, they may be considered “preferential payments.” This means the bankruptcy trustee may see these payments as an unfair advantage for one creditor over others, which could result in legal action to reclaim the funds.
To avoid legal complications, it’s advised to consult with an experienced bankruptcy attorney before making any large payments to creditors. For instance, waiting a year before filing for bankruptcy may allow you to repay family loans without facing repercussions from the court. Bruner Wright can offer expert guidance in these situations, helping you navigate the legal complexities and make informed decisions about repayment before filing for Chapter 11.
The Role of Legal Counsel in a Chapter 11 Bankruptcy
The Chapter 11 bankruptcy process can be overwhelming, especially when trying to balance the interests of multiple creditors. Having experienced legal counsel is crucial to ensuring your business’s restructuring plan is fair, transparent, and in compliance with bankruptcy laws. A knowledgeable attorney can help you understand who gets paid first in a Chapter 11 bankruptcy and ensure that the repayment plan prioritizes creditors appropriately while protecting your business’s assets.
At Bruner Wright, we have guided numerous businesses through the Chapter 11 process, ensuring that our clients achieve the best possible outcomes. Whether it’s working with secured creditors, negotiating with unsecured creditors, or advising on stockholder rights, our team has the experience and insight needed to successfully navigate bankruptcy and help businesses emerge stronger.
In Conclusion
In a Chapter 11 bankruptcy, understanding who gets paid first is critical to crafting a successful repayment plan and navigating the complex legal process. Secured creditors are the first in line, followed by unsecured creditors, and lastly, stockholders. Each group plays a role in the bankruptcy process, but secured creditors have priority because their loans are backed by collateral.
If you’re considering filing for Chapter 11, it’s essential to work closely with an experienced attorney to manage creditor relations, protect your assets, and comply with bankruptcy laws. At Bruner Wright, we’re here to guide you through every step of the Chapter 11 process, ensuring that your business can restructure successfully and move forward with confidence.