The Priority of Secured Credit

This chapter addresses one of the most controversial issues in the literature of insolvency law —whether and how the priority accorded to claims against an insolvent company is justified secured by a fixed charge or mortgage over the company's property. Some of this debate may be understood as being about, not whether the principles providing for the priority of secured claims serve the substantive goal of efficiency, but about whether they accomplish the objective of controlling debtor misbehaviour (one variety of motivation costs) only in a wasteful way, or worse, whether they allow for the exploitation of some types of parties by others. On this view, these arguments have a direct relevance to the project of this book. Exploited parties have not been treated as equals. And a rational scheme of fair co-operation would not tolerate waste. Such arguments also cohere with the rather simplistic pre-theoretical intuition that secured creditors are ‘obviously’ treated better than unsecured ones, which is unfair to the latter. The chapter uses economic theory and empirical data to find that these arguments are at best unproved, and more likely, false. It concludes by demonstrating that, taking into account the actual conditions under which security is demanded and offered, its priority over unsecured claims in the debtor's insolvency would in fact be part of a rational scheme of fair co-operation amongst equals.