Who Gets Paid In Chapter 11?

A new empirical study by Douglas Baird, a bankruptcy-law professor at the University of Chicago, Arturo Bris of the Yale International Center for Finance and Ning Zhu of the University of California, provides some interesting insights into the reality of who actually ends up getting paid in Chapter 11 bankruptcies. This is useful, because often, in economics, there a lots of factors that could theoretically be important, but a handful usually predominant in any given situation.

In Chapter 11 cases involving companies with assets of less than $200,000, "little or nothing" is left after the Internal Revenue Service has done its work . . . . Nonpriority general creditors get less than 10 percent of claims. . . When a company has assets worth more than $5 million, secured creditors, those whose claims are backed by collateral, receive 94 percent of what they are owed, and unsecured creditors typically recover half.

Tax claims get priority in bankrupcy cases, but it isn't at all obvious that this is good policy. Does the IRS really deserve to be higher in the pecking order than say, trade creditors, who sold goods or offered services on credit shortly before the company went under, who were often unaware that they were facing a serious credit risk? In construction cases, trade creditors can often trump all unsecured creditors, including the IRS, with mechanic's liens. Why should trade creditors in other circumstances receive less favorable treatment?