Chapter 11 bankruptcy allows businesses to reorganize finances and restructure their debts. Many companies are struggling to keep their operations going and meet their obligations. See Chapter 11 bankruptcy as a way to stay afloat. But understanding who gets paid first in Chapter 11 bankruptcy is crucial for both businesses and creditors. Chapter 11 has a strict hierarchy of payments that determines how various parties will be compensated.
This article will examine the Chapter 11 priority payment system and provide key insights to both businesses and creditors.
What is Chapter 11 Bankruptcy?
A business that files for Chapter 11 bankruptcy is essentially seeking protection from its creditors as it reorganizes debts and develops a plan of repayment over time. Chapter 11 bankruptcy allows the business to continue to operate while developing a plan for profitability. The process is complicated and involves financial negotiations. Not all creditors are treated equally.
This brings us to a critical question: Who gets paid first in Chapter 11 bankruptcy? The answer depends on a strict hierarchy to make sure certain obligations are met first. Understanding this hierarchy will help businesses make better financial decisions and creditors manage their expectations.
Understanding Payment Hierarchy
In Chapter 11 bankruptcy, the payment order is governed specifically by rules that give priority to certain creditors. Creditors are generally divided into three categories: secured creditors, unsecured creditors, and stockholders.
We’ll break down each of these categories in detail to better understand the hierarchy.
1. Administrative Expenses
Administrative expenses are at the top of the Chapter 11 payment hierarchy. This includes legal fees, accounting costs, and compensation for the bankruptcy trustee. Administrative expenses are prioritized because the bankruptcy process will stall without the professionals who provide these services. To ensure that the bankruptcy process goes smoothly, legal representation, professional advisors, and other costs related to the running of the case must be covered. Administrative expenses are given priority and are paid ahead of other creditors.
2. Secured Creditors
The next level of payment is secured creditors. Secured creditors are those who hold collateral or liens against the assets of the company. The secured creditors are often banks who have made loans that were secured by equipment or property, or lenders who hold mortgages for commercial buildings. Secured creditors receive payment before unsecured creditors because they have a legal claim to specific assets.
The value of the collateral is a major factor in determining how much a secured creditor receives. Secured creditors may be paid in full when the collateral is sufficient to cover the debt. If the collateral is less valuable than the debt owed, secured creditors may only receive the value of the security, with the remaining balance becoming part of the unsecured loan.
If a business defaults on a loan secured by real estate, then the secured creditor can sell the property and recover the debt. The proceeds of the sale will be used to pay the secured creditor, up to the amount of the claim. This ensures that the secured creditors are paid before the unsecured creditors.
3. Priority Unsecured Creditors
Priority status is given to certain unsecured creditors, which puts them above the general unsecured creditor in the Chapter 11 payment structure. They priority unsecured creditor debts include certain categories of debts which are considered to be more urgent than others. Unpaid wages, unpaid benefits, and certain tax obligations are examples. If a company owes taxes back or missed payroll, then these debts are considered priority unsecured.
These creditors receive payment after secured creditors but before general unsecured creditors. Priority unsecured obligations can have a significant impact on the payment structure of a Chapter 11 case. These obligations must be met before general unsecured creditors receive any payment.
4. General Unsecured Creditors
Priority unsecured creditors and secured creditors pay general unsecured creditors first. Suppliers, vendors, bondholders, and other businesses who do not have collateral to secure the assets of the company are included in this category. In many Chapter 11 cases, general unsecured creditors are not guaranteed to receive full payment. They are often paid a certain percentage of the debt owed, depending on the financial condition and reorganization plan.
A business may only pay a fraction of its total debt to suppliers because the funds are first used to pay secured creditors and priority unsecured creditors. It can cause tension with suppliers. This is one of the reasons businesses should carefully consider their reorganization plans.
5. Stockholders
In Chapter 11 bankruptcy, stockholders are the last in line to be paid. Stockholders, who are investors in the company, take on a greater risk than creditors. They are usually the last to be paid during a bankruptcy.
Stockholders are often not compensated in Chapter 11 cases. This is especially true if the assets of the company aren’t enough to pay secured and unsecured creditors. Stockholders may be able to retain their ownership, but their equity will often be diluted or they could lose their shares if the reorganization plan of the company involves issuing new stocks.
Can You Pay Your Creditors Before Filing for Bankruptcy?
Many business owners pay off creditors before declaring bankruptcy, particularly if they are family members or close friends. The Bankruptcy Trustee will closely examine these payments and, if made within 90 days of the bankruptcy filing date, they could be considered as “preferential payment.” The Trustee can sue for the payment to be recovered and then distribute it under the hierarchy of priority.
It is better to wait to repay a loan to a friend or family member until the bankruptcy has been resolved. Consult with legal counsel like the team from Bruner Wright PA to ensure that you avoid any complications during this time.
Summing Up!
Businesses facing financial problems must understand who gets paid first in Chapter 11 bankruptcy. By the payment hierarchy, administrative expenses, secured creditors, priority unsecured creditors, general unsecured creditors, and stockholders will be paid in order. To navigate this hierarchy, you will need professional legal advice and careful planning to make sure that all obligations are met.
Bruner Wright PA can help businesses who are considering Chapter 11 bankruptcy navigate the complicated process of debt repayments and financial restructuring.