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Order in the Liquidation Chain

1.    Concept of Bankruptcy and Liquidation

When a company goes bankrupt, a liquidation process of its assets is activated to pay its creditors in a legally predefined order. This process follows a payment hierarchy that determines who has priority in recovering their investments or credits.

Before delving into the payment hierarchy, it is essential to understand the concepts of bankruptcy and liquidation:

  • Insolvency: A financial state in which a company cannot pay its debts on time but may still attempt to restructure them.
  • Bankruptcy: An irreversible situation where a company cannot meet its financial obligations due to insufficient assets or cash flow.
  • Liquidation: A process through which the company's assets are sold to pay creditors according to a predetermined order.

2.    Types of Bankruptcy

Bankruptcies can be classified into different types depending on the process followed:

  • Voluntary bankruptcy: The company declares bankruptcy on its own and requests legal protection.
  • Involuntary bankruptcy: Creditors or regulatory entities force the company to declare bankruptcy.
  • Reorganizable bankruptcy: The company seeks to renegotiate its debts to continue operating.
  • Total liquidation bankruptcy: All assets are liquidated, and the company ceases to exist.

3.    Types of Creditors

There are several types of creditors in a liquidation:

  • Secured creditors: Hold guarantees over specific company assets, such as real estate or equipment.
  • Preferred creditors: Have priority over other creditors by legal mandate, such as employees and the government.
  • Unsecured or common creditors: Do not have guarantees and are paid after the preferred creditors.
  • Shareholders: Are last in the payment chain and only receive money if there is a remaining balance after satisfying all creditors.

4.    Payment Hierarchy in the Liquidation of a Company

The liquidation process is not carried out arbitrarily; instead, it follows a legally established framework. The payment hierarchy is crucial in determining which parties receive money first and which face the highest risk of loss.

4.11º  Administrative Expenses of the Liquidation

Before paying any debts, the costs of the bankruptcy process must be covered, including:

  • Fees for the trustee or bankruptcy administrator.
  • Legal and administrative expenses.
  • Operational costs during liquidation (e.g., facility maintenance, audits).

4.22º  Secured Creditors (Secured Debt)

Secured creditors have preferential rights over specific company assets. These are lenders who have provided loans backed by real collateral, such as mortgages or pledges on specific assets.

Examples:

  • Banks with mortgages on real estate properties.
  • Lenders with guarantees on machinery or equipment.

If the asset does not fully cover the debt, the remaining portion of the debt moves to the category of "unsecured creditors."

4.33º  Labor Claims and Tax Debts

In most jurisdictions, debts owed to employees and tax authorities take precedence over other unsecured creditors.

  • Labor claims: Salaries, severance payments, and benefits owed to employees.
  • Tax debts: Outstanding taxes owed to government entities.

4.44º  Unsecured Creditors (Subordinated Debt)

These creditors do not have specific guarantees on assets, making them more vulnerable to losses in the liquidation process.

Examples:

  • Suppliers without guarantees on their accounts receivable.
  • Lenders with unsecured loans.
  • Bondholders with subordinated debt.

4.55º  Shareholders and Owners

Common shareholders are the last in the payment chain. They only receive money if, after paying all creditors, there are remaining funds—something that rarely happens.

There are different types of shareholders in this hierarchy:

  • Preferred shareholders: Have priority over common shareholders if surplus assets remain.
  • Common shareholders: Are the last to receive money and, in most cases, do not recover their investment.

Steps in the Liquidation Process:

  1. Bankruptcy is declared in court.
  2. A bankruptcy administrator is appointed.
  3. An inventory of assets and liabilities is conducted.
  4. Assets are sold to generate funds.
  5. Creditors are paid in order of priority.
  6. The company is liquidated, and its legal registration is canceled.
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