Briefly describe the priority of claims in a Chapter 7 liquidation.

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Briefly describe the priority of claims in a Chapter 7 liquidation.

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Kimberly MacKenzie—president of Kim’s Clothes Inc., a medium-sized manufacturer of women’s casual clothing—is worried. Her firm has been selling clothes to Russ Brothers Department Store for more than 10 years, and she has never experienced any problems in collecting payment for the merchandise sold. Currently, Russ Brothers owes Kim’s Clothes $65,000 for spring sportswear that was delivered to the store just 2 weeks ago. Kim’s concern arose from reading an article in yesterday’s Wall Street Journal that indicated Russ Brothers was having serious financial problems. Moreover, the article stated that Russ Brothers’ management was considering filing for reorganization, or even liquidation, with a federal bankruptcy court.
 
Kim’s immediate concern is whether her firm will collect its receivables if Russ Brothers goes bankrupt. In pondering the situation, Kim has also realized that she knows nothing about the process that firms go through when they encounter severe financial distress. To learn more about bankruptcy, reorganization, and liquidation, Kim has asked Ron Mitchell, her firm’s chief financial officer, to prepare a briefing on the subject for the entire board of directors. In turn, Ron has asked you, a newly hired financial analyst, to do the groundwork for the briefing by answering the following questions:
 
Briefly describe the priority of claims in a Chapter 7 liquidation.

Explanation & AnswerSolution by a verified expert

Explanation

The priority of claims defines the order in which the creditors are paid. It is a part of Chapter 7 of the Bankruptcy Reform Act of 1978 that ensures equitable distribution of its assets among its creditors at liquidation. Secured creditors are the priority for the payment, followed by unsecured creditors, suppliers, employees, and banks.
Following is the priority of claims-

Secured creditors- They are the priority creditors paid from the proceeds of the particular assets that are pledged to them.
Trustee's costs-They are one of the priority claimants paid from the proceeds first.
Expenses incurred after beginning an involuntary case.
Worker's wages due-They are one of the priority claimants paid from the proceeds first.
Claims to employee benefit plans for unpaid contributions.
Unsecured claims
Taxes due to the federal, state, or local government are one of the priority claimants paid from the proceeds first.
General or unsecured creditors.
Preferred stockholders- These are paid after all priority, and general creditors are paid their claims in full. They may not receive anything if there are no sufficient funds to pay the creditors
Common stockholders- Any amount left after paying the preferred shareholders is paid to the common shareholders.

Verified Answer

The priority of claims is a part of Chapter 7 of the Bankruptcy Reform Act of 1978 that ensures equitable distribution of the company's assets among its creditors at liquidation.
Following is the priority of claims-

Secured creditors
Trustee's costs
Expenses incurred after beginning an involuntary case.
Worker's wages due
Claims to employee benefit plans for unpaid contributions.
Unsecured claims
Taxes due to the federal, state, or local government.
General or unsecured creditors.
Preferred stockholders.
Common stockholders.

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