Businesses file for bankruptcy when it becomes impossible for them to pay their debts on schedule with current cash flows. A stakeholder in bankruptcy is anyone to whom the company owes money. In common parlance, the term often refers to bondholders, but the list of creditors is often much broader than that, and includes vendors, property owners and employees who have outstanding unpaid wages. The bankruptcy courts must supervise the bankruptcy process and distribute the company's assets or available cash flows in the specific order described by law.
Chapter 7 Versus Chapter 11 Bankruptcy
In a business context, Chapter 7 refers to a liquidation bankruptcy, where Chapter 11 governs reorganization. In a Chapter 7 bankruptcy, the business is shut down and bankruptcy trustees sell off the assets of a business until creditors are fully satisfied. Once all creditors are paid off, the stockholders or company owners receive what is left over, if anything. If all the business assets are not enough to pay off creditors, those with the senior claims, as specified by law, get paid first. The remainder of the debt gets discharged, or canceled, and remaining creditors lose their investments. Under Chapter 11, the company can continue operations and pay back debts according to a modified schedule.
With debt, seniority refers to the legal status of the debt and where it falls in the legal order of priority. It has nothing to do with how long the debt has been in existence. Under bankruptcy law, the very first stakeholders are recipients of alimony and child support payments from company owners, followed by court administrators and attorneys. Certain government loan programs come next, if the loans were secured or guaranteed by the federal government.
Employees with recent outstanding unpaid wages, commissions or other unpaid compensation come next, provided the compensation was earned within 180 days prior to the bankruptcy filing. Each claimant in this category has a senior claim up to $10,000. Scheduled employer contributions to retirement plans come next.
Customers and Vendors
Next in the order of priority come customers, landlords and other business stakeholders who have claims due to unpaid rent, undelivered property or services or other similar claims. These stakeholders are satisfied in amounts up to $1,800 each before other debt holders are entitled to repayment.
Secured Debt Holders
After those in the above categories have been satisfied, those who have secured positions get paid next. These are generally bonds that are secured with collateral, such as a claim against tangible business assets or accounts receivable.
Unsecured creditors are those who have lent money to a business without securing any kind of collateral. Examples include business and personal credit card issuers and lenders. These creditors are last in the order of priority among debtors. If there are only enough assets available to satisfy some of the creditors in this category, all creditors will receive a partial, pro rata payment.