What Is the Order of Payment in Liquidation?

When a company ceases operations, its assets are sold to pay off its outstanding liabilities in a process known as liquidation. This distribution of funds follows a strict, legally mandated sequence. This framework dictates who gets paid first, and in what amount, from the limited pool of funds generated by selling the company’s assets. The process is designed to be orderly, though the outcomes can vary significantly for different types of claimants.

The Foundation of Payment Priority

The structure of payments in a corporate liquidation is built upon the Absolute Priority Rule. This rule, codified in the U.S. Bankruptcy Code, mandates that claims are paid in a descending order of seniority. A higher-ranking class of claims must be paid in full before any funds can be distributed to the next, more junior class, creating a “waterfall” effect until funds are exhausted.

Before any creditors receive payment, the first funds from the liquidation are used to cover administrative expenses. These are the costs associated with the liquidation process itself, including fees for the appointed trustee, attorneys, and appraisers hired to value and sell company assets. These expenses are paid first to ensure the process can be administered effectively, as without these professionals, the assets could not be properly collected and distributed.

Secured Creditor Claims

Following the payment of administrative costs, the next in line are secured creditors. A secured creditor is a lender who holds a claim backed by a specific piece of the company’s property, known as collateral. Common examples include a mortgage on a company’s office building, a loan secured by its fleet of delivery vehicles, or financing for specific manufacturing equipment.

Secured creditors are paid from the proceeds generated by the sale of their specific collateral. This gives secured creditors a significant advantage, as they have a direct claim on a tangible asset rather than waiting for a share of the general funds. Their recovery is tied to the value of the property they hold as security.

When the sale of the collateral does not generate enough money to cover the full amount of the debt, the remaining unpaid portion is known as a deficiency. This deficiency amount is reclassified. The creditor’s claim for the shortfall becomes a general unsecured claim, placing it in a much lower priority category for repayment.

Unsecured Creditor Claims

After secured creditors have been paid from their collateral, the process moves to unsecured creditors, who represent the largest and most diverse group of claimants. These claims are not backed by any specific asset. Within this broad category, the law creates two distinct tiers, establishing a further pecking order for payment.

The first tier is for Priority Unsecured Claims. Federal law grants these specific types of unsecured debts a higher status, meaning they must be paid in full before any other general unsecured creditors receive funds. These claims include:

• Employee wages, salaries, and commissions earned within 180 days before the bankruptcy filing, up to a statutory limit of $17,150 per employee
• Certain contributions to employee benefit plans
• Some tax obligations owed to government entities
• Deposits made by customers for goods or services that were never delivered, capped at $3,800 per individual

Once all priority claims are fully satisfied, any remaining funds are distributed to the final group of creditors: General Unsecured Claims. This is a broad, catch-all category for any debt not secured by collateral and not granted priority status by law. Common examples include suppliers who provided raw materials on credit, vendors for office supplies, and contractors who performed services.

If the money available is insufficient to pay everyone in this class in full, the funds are distributed on a pro-rata basis. This means each general unsecured creditor receives a percentage of what they are owed, proportional to their claim’s size. For example, if the total general unsecured claims are $1 million but only $100,000 is left, each creditor would receive 10 cents for every dollar they are owed.

Subordinated Debt and Equity Interests

At the very bottom of the payment hierarchy, after all creditors have been paid in full, are the holders of subordinated debt and equity interests. These claimants only receive a distribution if there are funds remaining after every other higher-ranking claim has been completely satisfied. In the vast majority of liquidations, the company’s assets are exhausted long before this level is reached, making recovery for these parties rare.

The first group in this final tier is holders of subordinated debt. These are investors who have, through a contractual agreement, agreed that their loans will rank lower than other forms of debt. Because they take on more risk, these loans usually carry higher interest rates to compensate the lender.

Following subordinated debt holders are the company’s owners, the equity holders. Within this group, there is also a pecking order. Preferred stockholders have priority over common stockholders and are entitled to receive their investment back first. Finally, if any funds remain after paying preferred shareholders, the common stockholders are entitled to the residue.