3.2.2.2. Liquidation
Chances are excellent that the liabilities of a company in Chapter 7 bankruptcy exceed the value of the company’s assets. Therefore, when those assets are liquidated, at least some creditors are going to receive less than they are owed—and in some cases, nothing at all. The bankruptcy priority rules prescribe the order in which creditors are paid and thus determine which creditors get made whole and which are doomed to the land of cliché (taking a haircut, holding the bag, coming up short, or getting stiffed).
A “claim” in bankruptcy is, broadly speaking, a right to payment, including disputed or contingent rights to payment. Claims in bankruptcy are either secured or unsecured, and the rights of a creditor depend on which of these categories its claims fall into.
A secured claim is a claim that is secured by a perfected lien, a security interest, or pledge of collateral, which might be real estate, equipment, cash, receivables, or other assets. A perfected lien is a lien that has been filed with the correct legal authority, typically a county or a court, giving the lien priority over other potential claimants to a property. Secured creditors enjoy the highest priority status of any creditor: they are paid from the collateral securing their claims before any unsecured creditor gets paid. Where there are multiple secured creditors, the creditors with senior claims—a first lien position, for example—are paid before secured creditors with a more junior position.
From a creditor standpoint, senior secured debt is the best class of corporate debt to hold. A company’s primary credit facility, such as a revolving line of credit, is typically senior secured debt that may be secured by a lien on all corporate assets. If the company owns real property, the mortgage on the property may be senior secured debt. In a liquidation, senior secured creditors get paid first.
Junior secured creditors also have secured claims in b