This text was written in 2012 but only published, with minor modifications and the odd addendum, in 2024.
I make the reservations that the legal situation in Germany (or elsewhere) could have changed in the interim and that I have not given the topic deeper renewed thought during my 2024 modifications.
I have not attempted to improve on the often ad-hoc terminology, but I do acknowledge that the text would be better if it used conventional technical terms. Ditto potential inconsistencies in terminology.
The often illogical way that the remainder of a bankrupt company’s assets and possessions are divided in Germany has long annoyed me. For instance, if a customer pays for an item in advance and the item is not delivered before the company enters bankruptcy proceedings, his money is not automatically repaid—instead he has to file a claim together with e.g. banks wanting repayment of multi-million Euro loans. Worse, if a customer has sent in an item for repairs, this item might become part of the proceedings—without in any way shape or form being the property of the company...
I am unaware of the details of the situation in other countries; however, problems in this area appear to be common. In the US, e.g., it seems that the bankruptcy process often amounts to lawyers and appointed administrators bleeding the company dry, while the actual claimants receive next to nothing. (Cf. e.g. SCO.)
SCO was a then current example of a bankruptcy and a company that had been of strong personal interest due to its spurious litigation against various Linux providers, the threat that this posed to Linux, and how a success in litigation could not only have put Linux in trouble but also provided a horrifying precedent for how a failing business could make money through litigation.
I do not recall what happened with the bankruptcy in further detail, but, in as far as SCO was bled dry by others, there is an element of karmic payback.
My suggestion is to adhere to the following order of priority:
Someone else’s property:
In the examples above, we simply have an issue of a possession of the company actually being the property of someone else. Examples include advance payments, items sent in for repairs, leased machinery, and personal belongings of employees (potentially including working equipment, e.g. a non-standard mouse brought in by some employee on his own dime). That such mere possessions must not be part of the “pot” should be obvious. Instead they should be returned to their respective owner at a suitable time. (That time is often “immediately” respectively “as soon as humanly possible”; however, exceptions can exist. Notably, if an item was sent in for repairs, and the business is still running, it can make sense to repair first and return later.)
Separating these cases from company-own property can be tricky in a practical situation. The brunt of the responsibility must fall upon the company, e.g. by keeping very clear inventories and marking items in a way that allows a manual inspection to determine the respective owners. In some cases, however, other parties might need to take action (or live with an increased risk), e.g. when an employee brings own equipment to work (possibly, without consulting his employer). Even more generally, it might be a sound precaution to mark even items sent in for repairs or leased-out with a clear “Property of X.” sign.
Debt through outstanding payments:
Debt arises through normal operations in form of outstanding payments of various forms (and possibly similar mechanisms). These include salary payments, bills for deliveries, and similar. They are closely related to the first category and should be paid next.
(A below section with remarks deal with several sub-issues.)
Bankruptcy costs:
The actual costs for the bankruptcy proceedings, administration, whatnot, come next (today, they regrettably typically come first): In doubt, this is an area where government intervention with money can actually be justified to do damage control and to ensure some amount of reliability and predictability of the overall system. More generally, government services (at least in some categories, most notably the execution of the law) should be free-of-charge: We already pay through our taxes. (Notably, the costs discussed should not be primarily for the benefit of the bankrupt company, but for the claimants: The law steps in to do damage control on their behalf.)
It is important that the administration is not done in a wasteful manner. In particular, it absolutely must not be that one law firm or another can use the bankrupt company as a cash-cow—while the original claimants just receive a fraction of their original claims.
Debt through formal loans:
This type of debt, e.g. bank loans, is given the least priority for a very good reason: Here the creditor has the opportunity to make qualified risk assessments in advance—and to compensate for that risk through e.g. a higher interest rate. In other words, he has just lost on a calculated risk in a “You win some; you lose some.” game. In this regard, his situation is radically different from the claimants in other categories.
Here my intent was (almost certainly) on more-or-less commercial lenders. Loans from other sources are possible, however, and it might be that some further differentiation is needed based on who the lender is, what conditions (notably, interest rate) is attached to the loan, and similar. It might e.g. make sense to give priority to a private one-off lender who gave a no-interest loan to a business owned by a friend over a bank that charges market rates with a risk markup.
The situations that can arise can be quite complex and the above should only be seen as the general principle to apply. Some complications are discussed below for more detail (however, even with the below, I make no claim to have made an even remotely full treatment of the issue).
Within the above categories, additional priority should be given when an element of fraud or undue caveat emptor is involved. For instance, if a bankrupt company continues to take orders over several channels, but only informs the customer of the associated risk over some of these channels, then the buyers who used the non-informing channels should be given priority.
The age of the claim could be a legitimate reason to make priority even more fine-grained; however, it will not always be clear whether younger or older debt should be given priority. Where a due date is present the earlier due date might be a better criterion for priority.
An interesting point is that someone who grants a loan (or otherwise takes a risk involving the business at hand) later will have had a better opportunity to foresee the bankruptcy than someone who does so sooner. Lenders who grant a loan after the bankruptcy must, unless mislead about circumstances, be given the least priority among lenders.
Within the second category, I would tentatively recommend that the common current practice of prioritizing salary/wage claims is continued: There is no inherent matter of justice in this; however, the average damage done to an employee who is not paid (or only paid after a delay) is worse than for most other claimants. (However, it cannot and must not justify that someone else’s property is stolen to cover salaries.)
Items that have been purchased by the business at hand, and that currently are (a) delivered, (b) unpaid, straddle the border of the two first categories and I am uncertain where to best put them. In theory, a good solution would be to simply return the items to the seller so that he can sell them to someone else—if the situation allows it. In other cases (including tailor-made products that might be unsellable on the market, products that spoil rapidly, and products that have already been used in a manner that lowers their re-sale value), the products might count as company-own property while the outstanding bill is grouped with the first or second category (I am uncertain which is more appropriate: going strictly by “bill”, the first would not be appropriate, but as the bill now substitutes for a return of the product at hand, a case for the first could be made). Giving the seller an explicit choice on whether the product should be returned might be the best option.
If the company (as seller) is actually able to deliver an ordered and paid item, this is obviously a legitimate alternative to repaying advance payments. However, if the customer has canceled his order, neither delivery nor payment in category 2. applies: We now have a case of someone else’s property and payment in category 1. must follow.
Loans based on some form of mortgage pose an interesting variation: I would tend to view the mortgaged item as someone else’s property to be delivered to the claimant in category 1. (with any remaining debt remaining in category 4. and, in the opposite case, any surplus value to be paid back to the bankruptcy estate). However, this view might need revision with increasing insight.
A particular problem is posed by taxes (and possibly other claims from the government). In principle, I would view these as the least priority; partly due to the reasoning in category 3., partly due to the fact that the government will get significant parts of what other claimants receive through indirect means, partly because the government is far better equipped to handle any loss. However, in practice, there is the danger that companies closing on bankruptcy would abuse such a regulation in a systematic manner.
(An obvious complication both here and with 3. is that the government will be hard to persuade to actually take its responsibility instead of its money.)
The complex issue of costs for on-going, post-bankruptcy operations is something that I have deliberately ducked above. If we assume that a particular company is in so dire straits that it will go to its grave, the above works well and on-going operations (except to serve already existing obligations and to do damage control for already existing claimants) should not take place. If, however, the company can actually be saved (which is often the hope), continuing operations must be considered—and this brings new complications.
However, by giving category 1. absolute priority and category 2. high priority, it should be possible to continue in a manner that, at least, does not unfairly disadvantage customers with an existing claim compared to new customers. Further, most ethical concerns are likely to be resolved.
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