Legal Definitions - preferred creditor

A preferred creditor is an individual or entity that holds a legal right to be paid before other creditors when a debtor is unable to pay all their outstanding debts. This priority is typically established by law or by a prior agreement, such as a security interest. In situations like bankruptcy or liquidation, preferred creditors receive payment from the debtor's available assets before general unsecured creditors.

Here are some examples to illustrate the concept of a preferred creditor:

• Example 1: Employee Wages in Company Bankruptcy

  Imagine a small tech startup goes out of business and files for bankruptcy. The company owes money to its employees for their last month's salaries, as well as to several software vendors and its landlord. In many legal systems, employees' unpaid wages and certain benefits are considered preferred debts. This means that the employees would be paid from the company's remaining assets before the software vendors or the landlord, who are typically considered general unsecured creditors.

  This example demonstrates a preferred creditor because the employees, by law, have a higher claim to the company's limited funds than other creditors, ensuring they receive their due compensation first.

• Example 2: Secured Mortgage Lender

  Consider a homeowner who defaults on their mortgage and subsequently declares personal bankruptcy. The bank that provided the mortgage loan is a preferred creditor because the loan is "secured" by the house itself. If the homeowner cannot pay, the bank has the right to foreclose on the property, sell it, and use the proceeds to recover the outstanding loan amount. Other creditors, such as credit card companies or personal loan providers, are unsecured and would only receive payment from any remaining assets after the mortgage lender has been satisfied.

  Here, the bank is a preferred creditor due to its security interest in a specific asset (the house), giving it priority over other creditors regarding that asset.

• Example 3: Government Tax Claims

  Suppose a restaurant owner files for bankruptcy, owing money to food suppliers, utility companies, and also significant back taxes to the national tax authority. In many jurisdictions, government tax claims are given a statutory preference. This means the tax authority would have a higher priority to collect the overdue taxes from the restaurant's assets than many other creditors, such as the food suppliers or utility companies, who are typically unsecured.

  This illustrates a preferred creditor because the government, by specific legal provisions, is granted priority in collecting its tax debts over other types of creditors.