The Bankruptcy Code, section 507, states that when a corporation is liquidated, creditors are paid in a particular order:
- Secured creditors, like secured bondholders.
Unsecured creditors - These are generally suppliers, employees, banks, and
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 paid.
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 (taxes), suppliers and investors who have unsecured bonds.
The last group of creditors 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 stocks and those who have common stock. The 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.
This question was answered by Chizoba Morah.
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