Legal Definitions - rule of marshaling securities

The rule of marshaling securities is a legal principle designed to protect junior creditors when a senior creditor has multiple sources of collateral, and one of those sources is also the sole collateral for a junior creditor. It is a specific application of the broader "rule of marshaling assets."

Under this rule, if a senior creditor has a claim against two or more assets (including securities like stocks, bonds, or mutual funds) belonging to a debtor, and a junior creditor has a claim against only one of those same assets (specifically, securities), the senior creditor may be compelled to satisfy their debt first from the assets that are *not* available to the junior creditor. This prevents the senior creditor from depleting the junior creditor's only source of recovery, thereby ensuring a fairer distribution of the debtor's assets among creditors.

Here are some examples illustrating the rule of marshaling securities:

• Example 1: Individual Borrower with Mixed Collateral

  A small business owner takes out a loan from Bank A, which is secured by both their personal residence (real estate) and a portfolio of publicly traded stocks (securities). Later, the owner takes a second loan from Bank B, which is secured *only* by the same portfolio of stocks. If the business owner defaults on both loans, Bank A is the senior creditor because its lien covers both assets, while Bank B is the junior creditor with a lien on only the stocks.

  How it illustrates the rule: Under the rule of marshaling securities, Bank A would likely be required to pursue repayment first from the personal residence before liquidating the stock portfolio. This action would preserve the stock portfolio, to the extent possible, for Bank B, which has no other collateral to recover its debt.

• Example 2: Corporate Debt with Diverse Assets

  A technology startup secures a large line of credit from a major investment firm (Senior Lender), which takes a lien on all the company's intellectual property (patents and trademarks) and its treasury bond holdings (securities). Separately, the startup obtains a smaller loan from a venture debt fund (Junior Lender), which is secured *only* by the company's treasury bond holdings. If the startup faces financial difficulties and defaults on its loans, the Senior Lender has access to both the intellectual property and the bonds, while the Junior Lender only has access to the bonds.

  How it illustrates the rule: The rule of marshaling securities would direct the Senior Lender to first recover its debt from the intellectual property. By doing so, it leaves the treasury bond holdings available, if sufficient, for the Junior Lender, preventing the Junior Lender from being completely shut out of recovery.

• Example 3: Estate Planning and Beneficiary Protection

  An individual passes away, leaving an estate with various assets, including a valuable art collection and a substantial portfolio of mutual funds (securities). The deceased had a large outstanding debt to a bank (Senior Creditor) that was secured by *both* the art collection and the mutual fund portfolio. A family member (Junior Creditor) had also lent money to the deceased, secured *only* by the mutual fund portfolio, as part of a private arrangement.

  How it illustrates the rule: To protect the family member's claim, the estate's executor, guided by the rule of marshaling securities, would ensure that the bank first seeks to satisfy its debt from the art collection. This action would preserve the mutual fund portfolio, if possible, for the family member, who has no other recourse within the estate for their secured loan.