Order of liquidation
Also known as: liquidation priority, liquidation policy
The order of liquidation is the sequence in which a bankrupt corporation's stakeholders are paid from the sale of its assets. Secured creditors are paid first, followed by unsecured creditors, subordinated debt holders, preferred stockholders, and finally common stockholders.
When a corporation goes bankrupt and its assets are sold off, the proceeds are distributed according to a strict order of liquidation. Each class of claimant must be paid in full before the next class receives anything, which is why the order matters so much to investors evaluating a company's securities.
The standard priority runs: (1) secured creditors, such as mortgage bond and equipment trust certificate holders, whose claims are backed by specific collateral; (2) unpaid wages and taxes; (3) general (unsecured) creditors, including trade creditors and holders of debentures; (4) subordinated debenture holders; (5) preferred stockholders; and (6) common stockholders. Common shareholders are last in line and frequently receive nothing.
This ordering explains the risk-and-reward tradeoff across a company's capital structure. Debt holders accept lower returns in exchange for a stronger claim on assets, while common stockholders accept the greatest risk of total loss in exchange for unlimited upside. It also explains why subordinated debentures pay higher yields than senior debt from the same issuer — their claim ranks lower.
The order of liquidation is a reliable test topic on the SIE and Series 7 exams. Expect questions that ask you to rank securities from safest to riskiest in a bankruptcy, or to identify which class is paid immediately before or after another. Remember the simple rule: secured debt first, equity last, with common stock at the very bottom.
Key takeaways
- The order of liquidation determines who gets paid, and in what sequence, when a bankrupt company's assets are sold.
- Secured creditors are paid first, followed by unpaid wages and taxes, general creditors, subordinated debenture holders, preferred stockholders, and common stockholders.
- Each class must be paid in full before the next class receives anything, and common shareholders often receive nothing.
- The SIE and Series 7 exams test ranking securities by liquidation priority, from safest (secured debt) to riskiest (common stock).