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Some commentators have urged that tort creditors should receive full compensation when the corporate tortfeasor goes bankrupt, either through a program of mandatory insurance or through the imposition of shareholder liability for corporate torts. Others have suggested that the law give tort creditors priority over secured claims (“superpriority”) in bankruptcy.

To the extent that any of these reform proposals are adopted, the parties could not use security interests to transfer bankruptcy value from tort claimants, and the problem of tort creditor nonadjustment would be eliminated. But as long as tort creditors are (1) not fully paid when a tortfeasor firm goes bankrupt or (2) not given superpriority over secured claims, a borrower will be able to “sell” some of the bankruptcy value that tort creditors would otherwise receive by creating a security interest that, under foil priority, completely subordinates their claims.

Government Tax and Regulatory Claims

Although tort claims against a bankrupt firm may in some cases be substantial, in aggregate, they are not as significant as the claims of the second group of involuntary creditors—federal, state, and local government agencies.

At any given point in time, firms will typically owe payments to federal, state, and local governments for corporate income taxes, withholding taxes on employees’ salaries, social security contributions, sales tax, property tax, excise tax, and customs duties. When the bankruptcy petition is filed, at least some of these taxing authorities will be creditors of the firm for taxes due yet not paid. In fact, tax claims against bankrupt firms are usually substantial, especially in the case of closely-held firms. The government may also have environmental, pension-related, and other non-tax claims against a bankrupt firm. Although these claims will not, unlike tax claims, be present in every bankruptcy, they may be substantial when they do arise.

This post was written by , posted on July 23, 2014 Wednesday at 3:40 pm