Preferred Creditor

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Preferred Creditor

What Is a Preferred Creditor?

A preferred creditor, sometimes known as a “preferential creditor,” is a person or organization that receives payment first if the debtor files bankruptcy.

Key Takeaways

  • When someone files bankruptcy, a preferred creditor is a person or corporation who receives payment first.
  • Depending on where you reside, the sorts of preferred creditors are established by legislation.
  • Unpaid salaries and taxes are often among the first costs paid.
  • When a debtor declares bankruptcy, it does not imply they will be free of all obligations.
  • Preferred bondholders have a better likelihood of retrieving any money owing to them.

Understanding Preferred Creditors

Bankrupt firms lack sufficient capital to meet all of their financial commitments, which means that some investors who are promised money will only be reimbursed in part or not at all. A preferred creditor usually has first claim to any cash available from the debtor. 1

In most legal systems, the sorts of creditors having priority status in bankruptcy proceedings are regulated by law and frequently include preferred bondholders and, in certain situations, tax agencies.

An economic development institution may also be a preferred creditor. For example, even though it is not stipulated in the contract, the World Bank may have priority in receiving repayment for a loan it granted to a nation experiencing a financial crisis.

Important

Preferred creditors’ claims may be covered totally or up to a set proportion.

Types of Preferred Creditors

Preferred creditors may take many various shapes or classifications, each having a claim that, depending on the jurisdiction, may take priority over another claimant. They are as follows:

  • Employees: The top preferred creditor is a worker at a bankrupt firm who is due remuneration for labor done (wages).
  • Tax and revenue agencies: Government tax authorities, such as the Internal Revenue Service (IRS) in the United States and HM Revenue and Customs (HMRC) in the United Kingdom, have the right to be paid first—after employees—for any tax due.
  • Environmental remediation: When insolvent corporations are shown to have caused environmental harm as a consequence of their commercial activities, the courts may give the clean-up expenditures priority consideration.
  • Tort victims: In certain countries, victims of such a “civil wrong” may be granted preferred creditor status based on their position as an involuntary creditor. Tort victims are often not punished since they did not want to become creditors to a bankrupt entity.2
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Dec. 2020

After an 18-year period as an unsecured creditor with little possibility of retrieving any money owing from bankrupt firms entering administration, the United Kingdom’s tax office, HMRC, reverted to favoured creditor status on this day. 3

Preferred Creditors vs. Unsecured Creditors

An unsecured creditor is a person or organization that loans money without requiring specific assets as security. Priority unsecured creditors and general unsecured creditors are the two types of unsecured creditors.

When it comes to claims over any assets in a bankruptcy case, unsecured priority creditors are higher in the pecking order than ordinary unsecured creditors, as the name implies. However, when a person or firm is unable to repay their existing obligations, the resources of economic worth they possess are often insufficient to fully refund priority unsecured creditors.

In the United States, the following is the order of creditor and contributing rating on a debtor’s insolvency:4

  1. Secured claims
  2. Administrative costs and prioritization of claims
  3. General unsecured claims
  4. Subordinated claims
  5. Equity interests

Meanwhile, in the U.K. the creditor order is:4

  1. Fixed charge holders
  2. Liquidators’ fees and expenses
  3. Preferred creditors
  4. Floating charge holders
  5. Unsecured creditors
  6. Interest on all unsecured debts accrued after liquidation
  7. Shareholders

Special Considerations

Preferred creditors often take priority over unsecured creditors. However, as seen above, in certain countries, preferred creditors are more likely to be paid than secured creditors whose security is floating, while those with a fixed charge take a second seat.

Banks and other lenders who hold title to company assets are typically classified as fixed charge.

What Is the Difference Between Preferred and Unsecured Creditors?

During bankruptcy, preferred creditors get payment first, while unsecured creditors are less likely to receive any assets.

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Who Are Preferred Creditors?

Employees, the IRS or other tax authorities, anybody involved in environmental cleanup, and tort plaintiffs are preferred creditors.

Will I Be Paid If My Employer Goes Bankrupt?

If your firm files bankruptcy, you will be considered a favored creditor. You will be the first preferred creditor on the list of debts to be paid if you are due salary.

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