Which of the following are ordered correctly in the order of debt seniority in a bankruptcy situation?

Which of the following are ordered correctly in the order of debt seniority in a bankruptcy situation?

I. Equity, Subordinate debt, Senior debt

II. Senior debt, Preferred stock, Equity

III. Secured debt, Accounts payable, Preferred stock

IV. Secured debt, DIP financing, Equity
A . II and III
B . I and IV
C . I
D . II, III and IV

View Answer

Answer: A

Explanation:

In a bankruptcy, equity ranks last. Preferred equity is one level above equity. Senior debt gets paid out first compared to junior debt, and secured debt is paid out first to the extent of the asset securing it (after which it counts as unsecured debt). Accounts payable and other short term liabilities are treated like unsecured creditors. Debtor-in-possession (DIP) financing ranks higher than any other asset as it is financing secured after the bankruptcy to continue the business.

Based on the above, statement I does not represent a correct ordering of seniority as equity is paid last. Similarly, DIP financing receives higher priority than even secured debt, and therefore statement IV is incorrect. Therefore the only correct statements are II and III and Choice ‘a’ is the correct answer.