What Is a Preferred Creditor?
A preferred creditor, also known as a "preferential creditor", is an individual or organization that has priority in being paid the money it is owed if thedebtor declaresbankruptcy.
Key Takeaways
- If someone declares bankruptcy, a preferred creditor is an individual or company that has priority in being paid.
- The types of preferred creditors are defined by law depending on where you live.
- Unpaid wages and taxes are often among the first expenses covered.
- When a debtor declares bankruptcy it doesn't mean they will not have to pay any debts.
- Preferred bondholders usually have avgreater chance of recovering any money owed.
Understanding Preferred Creditors
Bankrupt entities do not have enough capital to fulfill all of their financial obligations, meaning that some investors who are owed money will get paid in part or not at all. Usually, a preferredcreditorhas the first claim to any funds that are available from the debtor.
In bankruptcy cases in most legal systems, the types of creditors withpreferential status are defined by law and commonly includepreferred bondholders, and sometimes tax authorities.
A preferred creditor can also be an economic development institution. For example, the World Bank might have priority to be repaid a loan it made to a country that experiences afinancial crisis, even if this wasn't specified in the terms of the contract.
Important
The claims of preferred creditorsmay be covered entirely or up to a certain percentage.
Types of Preferred Creditors
Preferred creditors can take many different forms or classes, each with a claim that may take precedence over another claimant depending on the jurisdiction. They include:
- Employees: Workers at a bankrupt company who are owed pay for work that has been performed (wages) are the top preferred creditor.
- Tax and revenue authorities: 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 for any tax liability before anyone else—after employees.
- Environmental remediation: When bankrupt companies are adjudged to have caused environmental damageas a result of their business operations, the clean-up costs might receive preferential treatment by the courts.
- Tort victims: Victims of such a "civil wrong" may be given preferred creditor status in some jurisdictions based on their status as an involuntary creditor. Since tort victims did not make the choice to become a creditor to a bankrupt entity, they are generally not penalized.
Dec. 2020
The date the U.K.'s tax authority, HMRC, returned to preferential creditor status after an 18-year stint as an unsecured creditor with little hope of recovering any money owed from insolvent companies entering liquidation.
Preferred Creditors vs. Unsecured Creditors
Anunsecured creditor is essentially an individual or institution that lends money without obtaining specified assets as collateral. Unsecured creditors are generally placed into two categories: priorityunsecured creditors and general unsecured creditors.
As their name suggests, unsecured priority creditors are higher in the pecking order than general unsecured creditors when it comes to claims over any assets in a bankruptcy filing. That said, when a person or business is unable to repay their outstanding debts, the resources of the economic value they hold are usually not sufficient enough to reimburse priority unsecured creditors entirely.
In the U.S., theorder of creditor and contributory ranking on a debtor's insolvency is as follows:
- Secured claims
- Administrative expenses and priority claims
- General unsecured claims
- Subordinated claims
- Equity interests
Meanwhile, in the U.K. the creditor order is:
- Fixed charge holders
- Liquidators' fees and expenses
- Preferred creditors
- Floating charge holders
- Unsecured creditors
- Interest incurred on all unsecured debts post-liquidation
- Shareholders
Special Considerations
In general, preferred creditors take precedence over unsecured creditors. However, in some jurisdictions, as you can see above,preferred creditors are more likely to get paid than secured creditors whose security is floating, while, at the same time, taking a back seat to those with a fixed charge.
Banks and other lenders who hold title over business assets usually fall into the fixed charge category.
What Is the Difference Between Preferred and Unsecured Creditors?
Preferred creditors take priority for payment during bankruptcy, but unsecured creditors are less likely to be paid out any assets.
Who Are Preferred Creditors?
Preferred creditors are employees, the IRS or other tax authorities, anyone related to environmental remediation, and tort victims.
Will I Be Paid If My Employer Goes Bankrupt?
You will be considered a preferred creditor if your company declares bankruptcy. If you are owed wages, you will be the first preferred creditor on the list of debts to be paid.
FAQs
If someone declares bankruptcy, a preferred creditor is an individual or company that has priority in being paid. The types of preferred creditors are defined by law depending on where you live. Unpaid wages and taxes are often among the first expenses covered.
What is an example of a preferred creditor? ›
Below are preferential creditors in more detail:
- Company employees. The first and most important preferential creditor is company employees. ...
- Protective awards. ...
- Tort victims. ...
- Financial Services Compensation Scheme (FSCS) ...
- Environmental concerns.
Preferential creditors are a specific category of creditors with priority in the event of the debtor's insolvency. These creditors have certain legal privileges, allowing them to be repaid before other creditors. Tax authorities and employees with unpaid wages are often considered preferential creditors.
What is a preference in payment of creditors? ›
In simple terms, preferential payments refer to the debtor choosing one creditor over others. This preference might be the result of various factors, such as personal relations with a creditor, strategic business decisions and an effort to secure future credit.
What is an example of a preferential liability? ›
(a) Employees: Unpaid wages, salaries, and accrued holiday pay owed to employees are considered preferential debts. This is because employees have provided their time, skills, and labour to the company, and their compensation is seen as a high priority.
How does preferred debt work? ›
Preferred debt is a financial obligation that's considered more important than—or takes priority over—other types of debt. This type of debt obligation typically has to be paid first because it carries more significance than other types of debt. Interest on preferred debt is typically free from any taxes.
What are the three types of creditors? ›
Examples of common creditors
There are several types of creditors, such as real creditors, personal creditors, secured creditors and unsecured creditors.
What is the creditor preference rule? ›
To avoid unfairness, bankruptcy law allows a preference claim, which seeks to recover moneys paid to a creditor before a bankruptcy was filed to become part of the pool of money used to pay all creditors. Only certain payments need to be refunded. Bankruptcy law sets forth requirements as well as defenses.
What is the preferential payment rule? ›
The U.S. Bankruptcy Code contains a statute, Section 547 (or preferential-payment rule). It states when a debtor pays a creditor within 90 days of filing, the court can force the creditor to pay that money back so it can be dispersed among other creditors.
What are examples of preferential payments? ›
The preference might be given to the timing of the payment as well as to the value. For example, a director who suspects that the company may shortly become insolvent might: repay a loan to a person connected to the company, such as another director, or his or her wife (a possible shadow director)
In other words, if a creditor provides new goods and/or services and receives payment at substantially the same time, the payment will not receive preference treatment. An example of such a contemporaneous exchange would be payments received on a C.O.D.
What is an example of preferential? ›
Something that's preferential gives one person or group a big advantage over others. If your soccer coach never makes you sit on the bench and always hands you the first Gatorade, she gives you preferential treatment.
What is the preferential payment clause? ›
A demand for preferential payment asserts that a payment was made by the company when it should not have been and is a voidable transaction. The liquidator seeks return of the payment to ensure that all money and assets are properly distributed to creditors.
What is an example of a personal creditor? ›
Personal creditor: If someone borrows money from a friend to make a purchase, the friend that lends the money is considered the personal creditor. For example, if someone borrows money from their friend to buy a new bike, the friend who provides the funds for this purchase is the personal creditor.
What is an example of preferred stockholders? ›
What Is an Example of a Preferred Stock? Consider a company is issuing a 7% preferred stock at a $1,000 par value. In turn, the investor would receive a $70 annual dividend, or $17.50 quarterly. Typically, this preferred stock will trade around its par value, behaving more similarly to a bond.
Which of the following is an example of a creditor? ›
Creditors are individuals or entities that have lent money to another individual or entity. They typically charge interest and the money is owed back to them. For example, a bank lending money to a person to purchase a house is a creditor.
What are examples of creditor companies? ›
What is an example of a creditor?
- Friend or family member you owe money to.
- Financial institution, like a bank or credit union, that extends you a personal loan, installment loan, or student loan.
- Credit card issuer.
- Mortgage lender.
- Auto dealer that extends you a car loan.
