Legal Definitions - rule of marshaling assets

The rule of marshaling assets is a legal principle rooted in fairness, designed to ensure that when a debtor owes money to multiple creditors, the available assets are distributed as equitably as possible.

It applies when:

• There is a senior creditor (the one with the primary claim or first right to payment) who has the right to claim payment from two or more of the debtor's assets.
• There is also a junior creditor (one with a secondary claim) who has the right to claim payment from only one of those same assets.

Under this rule, the senior creditor is required to first seek satisfaction of their debt from the asset(s) that are not available to the junior creditor. This prevents the senior creditor from unfairly depleting the only asset available to the junior creditor, which would leave the junior creditor with nothing.

Here are some examples to illustrate this principle:

• Real Estate Scenario: Imagine a homeowner, Sarah, who owns two properties: House A and House B. Sarah takes out a large loan from Bank One, securing it with a mortgage on both House A and House B. Later, she takes out a smaller second loan from Bank Two, securing it only with a mortgage on House A. If Sarah defaults on her loans, Bank One (the senior creditor) would be required by the rule of marshaling assets to first try and recover its debt by selling House B. Only if the proceeds from House B are insufficient to cover Bank One's debt could they then pursue House A, thereby preserving House A as much as possible for Bank Two (the junior creditor) to recover its smaller loan.

• Business Inventory and Equipment: Consider a small manufacturing company, "Widgets Inc.," that obtains a significant loan from Lender X, securing it with a lien on all of its inventory and manufacturing equipment. Later, Widgets Inc. takes out a smaller, specialized loan from Lender Y, securing it only with a lien on its manufacturing equipment. If Widgets Inc. faces financial difficulties and defaults on both loans, Lender X (the senior creditor) would be compelled to first sell the company's inventory to satisfy its debt. This action leaves the manufacturing equipment available for Lender Y (the junior creditor) to claim, ensuring that Lender Y has a chance to recover its investment from the only asset it has a claim against.