First Secured Debt Takes Priority, Subordinate Debt Loses
The rule is simple and everyone involved understands it as it is the law of the land. In foreclosure, the first secured note wins. That means the secured creditor who files security interest first in the public registries has priority whether it’s a UCC security interest on inventory, equipment, receivables, or a mortgage on land or real estate.
This means the first filed priority interest – that’s first by date of filing – must receive every dollar it is owed before the second filed secured interest gets its first dollar. And then, when the second is paid in full, the third and then the fourth and so on until the money is exhausted.
The unsecured creditors must wait until all the secured creditors are paid in full before the unsecured debts are paid at all. This is the order of priority of payoff in a liquidation situation.
This is also the basis of much strategy as it is easy to predict who will get what and thus the strategy and negotiation follows the order of priority as the recipient is weaker and weaker the lower on the priority list they are. This is part of the basis of a workout negotiation.
This also means that the higher priority lien-holders are supportive of your efforts for obvious reasons and can be very helpful in getting lower priority interests to cooperate.
This does not mean that lower priorities do not have enforceable debt – they do – it simply means they may not be included in this distribution. It does mean, however, that the unsecured debt is typically noncollectable if the secured creditors do not get paid in full.
Of course, keep in mind personally guaranteed debt is also considered secured by the personal net worth of the guarantor, a weaker, yet valid, form of strengthening the unsecured position to the extent there is any net worth of the guarantor. Even if no net worth remains, there is still value of the personal guaranty as it remains until satisfied or discharged by negotiation.
This is very important and must be understood and evaluated in a workout situation as any strategy must be built around these priorities.
