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Hierarchy of Creditors

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A creditor is a person to whom someone is owing money. Members of an organization who contribute their assets to the company are creditors of the company with respect to the property owned by the company. The creditor can apply to the court for an order of liquidation, when the company becomes insolvent and unable to pay the debt (Morse & Worthington, 2010). In relation to the bankruptcy, where the debtor is not in the position to meet his debt obligation, a creditor can apply to the court to have the debtor declared bankrupt. The court can issue a receiving order on the probe of debt by the debtor.

The aim of liquidation in the instances when a company is insolvent is to gather its assets and distribute them using the order provided by the law (Goode, 2011). Before the claims are satisfied, secured creditors have the right to impose their claims against the property of the company to the degree that they are entitled to the particular security interest. In most instances, fixed securities take precedence over all debts. Security in the floating form charge may be suspended in the favor of the preferred creditors. Applicants with the non-pecuniary claims against the company may be able to impose their ownership rights on the company’s assets. After taking of all assets, which are subject to the holding of title arrangement, to fixed security, and those that form subject of the proprietary entitlements of others, the receiver will settle the debts against the company's property (Hannigan, 2012).  While settling the claims against the company, the priority of debt will be determined according to the law. The creditors will rank as follows:

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  • Firstly, liquidator costs, costs due to audit, costs and expenses incurred during the process of liquidation, and taxed cost of the petitioner. Payables are pursuant to the section 220;
  • Creditors with a fixed charge over assets, which is payable by the company to the creditors who have obtained security over some assets of the firm. Creditors in this case are entitled to obtain the sales proceeds from these assets;
  • Costs incurred by an administrator;
  • Preferential creditors to whom the company owes the money. It is a preference for them to be refunded first.
  • The amounts due to the employees for wages and salaries comprising amount payable by the way of allowance or compensation under any contract of employment;
  • Payments due in for the employees injuries;
  • Amounts due to the employees for the leaves, or in case of death - to any other person in his right, under any written law, accrued over any period prior to the start of the liquidation process;
  • Compensation payments due to the employees under any written law incurred before the beginning of the liquidation process;
  • Creditors with floating charge over assets. Floating charges are the charges that are not attached to a specific asset of the company;
  • Unsecured creditors;
  • Shareholders are paid last, because they are the owners of the company.

The debts of each category are ranked in the abovementioned order. However, creditors in the same group shall be ordered equally and shall be paid the whole sum owed. Where there is any payment made to any employee concerning wages or leave out of money progressed by a person for that specific reason, the person by whom the amount was given shall have priority. In the process of the bankruptcy distribution, the creditors’ claims are paid in the order of priority. It means that some creditors’ claims are paid before the others (Armour, Wen-hsin Hsu & Walters, 2012). The creditors are categorized by classes, and each class must be paid in full before the subsequent class is paid. The order is the following:

  • Firstly, any outstanding portion of the US Bankruptcy Court filing fee is settled;
  • Secured claims with charges and mortgages and tax on assets rank second;
  • The next class is unsecured creditors. The first category of unsecured debt is the family support, such as child support or allowance. The second category of the creditors is the administration expenses. The administration costs of bankruptcy include the referee's fee, accountant's fees, clerk's fee, and trustee's fee;
  • The third priority is given to the payments that encompass the employee's outstanding wages, operating costs incurred during the bankruptcy proceedings, fee owed to a lawyer during bankruptcy proceedings, and the tax due to withholding. The Debtor in Possession (DIP) financing falls in this category and has a priority claim over any financing;
  • The chapter 11 filing excludes payment for seller's obligations sustained prior to the filing date. The invoices for the obligations are taken as the pre-petition claims;
  • Some sellers may have a claim over the inventory
  • As with the Debtor in Possession post-petition, sellers are paid in advance of all unsecured creditors, according to the court's approval;
  • The subsequent priority claim is that of the unsecured creditors. Within this category, there is a sub-hierarchy consisting of banks, followed by the bondholders and stockholders, who are essentially the owners of the company;
  • The last priority is given to the unsecured creditors, which are the federal taxes. Taxes in this category include property tax, tax liable to debtor, and income tax accrued before the commencement of the liquidation.

The claims of unsecured creditors have the last priority. Each priority class of creditors must get their full payment prior to any creditor of the below class getting paid. Hence, all priority debts must be paid in the whole owed amount prior to paying any lower unsecured class. Where there is not enough money remaining to pay a priority class in full amount, members in that group receive equal portions of the remaining amount (Lucas, 2014).

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