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Liquidation of Distressed Companies: Who Has Priority in Debt Recovery When Assets Are Distributed?

Introduction

When a company becomes financially distressed and stops meeting its financial obligations, the problem extends beyond a shortage of liquidity or declining sales. A more critical question arises: What happens when the company’s assets are insufficient to pay all creditors? Who receives payment first? Does a bank holding security over one of the company’s assets have the same priority as a supplier claiming overdue invoices or an employee who has not received their salary?

These questions become particularly important when liquidation proceedings begin, as the distribution of assets is not conducted arbitrarily. Nor does it mean that every creditor receives an equal share of the available funds. Instead, the process is governed by legal provisions that establish creditor priorities, taking into account the nature of each debt, any associated security interests, and the type of liquidation procedure applicable to the company.

In the Kingdom of Saudi Arabia, the Companies Law regulates the liquidation of companies following their dissolution, while the Bankruptcy Law addresses cases involving financial distress or insufficient assets to settle debts. It also establishes specific rules for distributing the proceeds from the sale of bankruptcy estate assets among creditors.

In this article, we examine the order of priority among creditors, the difference between ordinary liquidation and liquidation under the Bankruptcy Law, the rights of banks, suppliers, and employees, and the steps creditors can take to protect their claims before company assets are distributed.

First: What Is the Liquidation of a Distressed Company?

Company liquidation is a set of legal procedures intended to terminate the company’s operations and settle its rights and obligations. This involves identifying its assets and debts, converting the necessary assets into cash, and then paying creditors according to the legally established order of priority. Any remaining surplus is handled in accordance with the applicable law and the company’s Articles of Association or bylaws.

However, it is important to distinguish between two different situations:

1. Ordinary Company Liquidation

A company may be dissolved by a decision of its partners or shareholders, or for another legally recognized reason. It then enters the liquidation phase.

If its assets are sufficient to cover its debts, the liquidator manages the liquidation process, identifies the company’s obligations, and settles outstanding debts according to their priority, while setting aside the amounts necessary to cover deferred or disputed debts.

2. Liquidation in Cases of Financial Distress or Insufficient Assets

The situation is different when it becomes clear that the company’s assets are insufficient to cover its debts, or that the company is financially distressed under the provisions of the Bankruptcy Law.

In this case, ordinary liquidation procedures alone are not sufficient. The liquidator must take the appropriate legal action and apply to the competent judicial authority to commence the relevant liquidation procedure under the Bankruptcy Law.

This highlights the importance of identifying the correct legal procedure, as creditor priorities and the distribution of proceeds from asset sales under bankruptcy liquidation are subject to specific rules. These rules should not be treated as identical to those governing every form of ordinary liquidation.

Article 254 of the Companies Law addresses this matter by requiring the liquidator to immediately notify the partners or shareholders and the company’s creditors if the assets appear insufficient to cover its debts, and to apply to the competent judicial authority to commence the appropriate procedure under the Bankruptcy Law.

Second: Do All Creditors Receive Equal Payment?

The answer is: No.

The distribution of a distressed company’s assets is not based on mathematical equality among all creditors. Instead, it follows the order of priority established by law.

This is because financial obligations differ in nature. They may include debts secured by collateral, employee wages, financing obligations, unsecured commercial receivables, and government fees and taxes.

For example, a company may own a property mortgaged to a bank as security for financing. At the same time, it may have outstanding supplier invoices, unpaid employee salaries, and claims from other parties.

When assets are sold and the proceeds are distributed, each party does not automatically receive an equal percentage of the total amount. Instead, the priority of each debt, the scope of any security interest, the nature of the claim, and whether the debt is established and accepted or disputed must all be considered.

It is also important to understand that priority does not guarantee full repayment. The value of a mortgaged asset may be lower than the secured debt, or the available assets may be insufficient to cover all debts within the same priority level.

Third: Creditor Priority in Liquidation Proceedings Under the Bankruptcy Law

Article 196 of the Saudi Bankruptcy Law establishes the order of priority for debts in liquidation proceedings and small debtor liquidation proceedings. Article 195 also provides for the payment of the bankruptcy trustee’s fees and expenses, expert fees where applicable, and the costs of selling assets before distributing the proceeds to creditors.

This order can be explained as follows:

1. Bankruptcy Trustee Fees and Expenses and Asset Sale Costs

Before distributing the proceeds from the sale of bankruptcy estate assets among creditors, the bankruptcy trustee’s fees and expenses, any expert fees, and the costs necessary for selling the assets must be paid.

This category includes the costs associated with managing the liquidation procedure and carrying out the work required to identify, sell, and distribute the proceeds from the assets.

Under Article 195 of the Bankruptcy Law, these expenses must be paid before the distribution of proceeds to creditors. They must therefore be taken into account when calculating the amounts available for distribution.

2. Debts Secured by In-Kind Security

Debts secured by in-kind security occupy the first position among the debt categories listed in Article 196.

Examples of in-kind security include real estate mortgages and commercial pledges, provided that the security meets the legal requirements and is enforceable against the relevant parties.

The importance of this type of security lies in the fact that the creditor’s right is connected to a specific asset, giving the creditor priority in recovering the debt from the proceeds of that asset, subject to the applicable legal provisions and registered security rights.

Practical Example:

A company obtains financing from a bank and provides a property it owns as security for the financing. After the company becomes financially distressed and liquidation proceedings commence, the property is sold for SAR 1 million, while the secured debt amounts to SAR 800,000.

In this case, the secured creditor’s priority in recovering the debt from the proceeds of the secured asset is taken into account. Any amount exceeding the secured debt is deposited into the bank account designated for the bankruptcy estate’s assets.

However, if the secured asset is sold for an amount lower than the debt, the portion not covered by the sale proceeds is treated as an unsecured debt, in accordance with Article 197 of the Bankruptcy Law.

This distinction is important because security does not automatically make the entire debt secured regardless of its value. Priority is linked to the value of the asset and the secured right associated with it.

3. Secured Financing

Secured financing falls within the subsequent priority categories following debts secured by in-kind security, subject to the requirements set out in the Bankruptcy Law and its Implementing Regulations.

It is important to distinguish between financing obtained by the company before the commencement of proceedings and financing granted during bankruptcy proceedings in accordance with the applicable legal requirements. This is because the law addresses certain forms of financing necessary for business continuity under a specific priority framework.

Simply describing an amount as financing does not automatically grant it priority. Its eligibility must be assessed based on the applicable legal requirements, the nature of the security, the relevant approvals, and the associated procedures.

4. An Amount Equivalent to Thirty Days’ Wages for the Debtor’s Employees

The Bankruptcy Law grants priority to an amount equivalent to thirty days’ wages for the debtor’s employees.

This reflects the importance of protecting employees and ensuring that their entitlements are not left entirely to the later stages of distribution, particularly because wages represent a primary source of income for employees and their families.

However, this specific priority must be distinguished from other outstanding wages, as the law assigns each category a separate position in the order of priority.

5. Family Support Payments Established by Law or Court Judgment

The law includes family support payments established under a statutory provision or court judgment within the priority order.

This category relates to the nature of the debtor and the cases to which its provisions apply. Therefore, it should not be assumed that it applies to every company simply because it appears in the list of priorities. A company, as a legal entity, differs from an individual debtor in terms of the nature of family obligations.

6. Expenses Necessary for Continuing the Debtor’s Business During Proceedings

Bankruptcy proceedings may require certain business activities to continue for a specific period, whether to preserve the value of assets, complete ongoing operations, or achieve a better outcome for creditors.

For this reason, the law grants priority to expenses necessary for continuing the debtor’s business during the proceedings, subject to the requirements specified in the Implementing Regulations.

Debts necessary for business continuity that arise after the commencement of bankruptcy proceedings are considered expenses incurred during the proceedings, as explained in Article 77 of the Implementing Regulations of the Bankruptcy Law.

This does not mean that all expenses incurred by a company after becoming distressed receive the same priority. They must be related to business continuity and meet the applicable legal requirements.

7. Outstanding Employee Wages

Following the preceding categories, other outstanding employee wages fall within the priority order established by the Bankruptcy Law.

A distinction must be made between the wage amount equivalent to thirty days, which the law grants a separate priority, and the remaining outstanding wages owed to employees.

Employees or their representatives must provide evidence of the employment relationship, the outstanding wages, and the period for which payment has not been made, so that the claim can be reviewed and included among the debts payable under the proceedings.

8. Unsecured Debts

This category includes a wide range of commercial claims that are not connected to specific in-kind security.

Examples include supplier invoices, amounts owed to certain service providers, and contractual obligations for which no in-kind security has been provided to grant the creditor a higher priority.

This category is particularly important in cases of corporate financial distress because many commercial transactions rely on trust and credit arrangements without requiring a mortgage or other form of in-kind security.

Nevertheless, the absence of security does not mean that the claim has no value. A creditor can still prove the debt and claim payment, but its distribution priority differs from that of a creditor holding in-kind security.

9. Unsecured Government Fees, Contributions, Taxes, and Other Government Dues

Unsecured government fees, contributions, taxes, and other government dues fall within the final category listed in the priority order under Article 196, subject to the provisions of the Implementing Regulations.

These dues should not be confused with government claims that may enjoy a different priority under a specific legal provision. The nature of the claim and the applicable statutory provision determine its treatment.

Important Note: The above priority order applies specifically to liquidation proceedings and small debtor liquidation proceedings under the Bankruptcy Law. It should not automatically be applied to every type of liquidation or enforcement procedure without first verifying the legal framework governing the case.

Fourth: What Happens If the Company’s Assets Are Insufficient to Pay All Debts?

All available assets may be sold, yet the proceeds may still be insufficient to cover the company’s debts in full.

In this situation, creditors are not necessarily paid their entire outstanding amounts. Instead, the law applies distribution rules based on the established order of priority.

Article 198 of the Bankruptcy Law provides that the proceeds from the sale of bankruptcy estate assets are distributed among creditors holding the same priority. If the proceeds are insufficient to settle their debts, the available amount is distributed among them on a pro rata basis.

This means that the available amount is divided among creditors of equal priority in proportion to the value of each creditor’s debt, rather than paying one creditor in full while excluding the others simply because their claims were submitted at different times.

Illustrative Example:

Assume that three suppliers have unsecured debts owed by the company, as follows:

Supplier One: SAR 200,000.
Supplier Two: SAR 100,000.
Supplier Three: SAR 100,000.

The total debts within this priority category amount to SAR 400,000, while the amount available to this category after paying higher-priority claims does not exceed SAR 200,000.

In this case, each creditor receives 50% of the value of their claim:

Supplier One: SAR 100,000.
Supplier Two: SAR 50,000.
Supplier Three: SAR 50,000.

This simplified example illustrates the principle of pro rata distribution among creditors of equal priority. It does not replace an examination of the nature of each claim and the legal requirements applicable to the specific case.

Fifth: Does a Bank Receive Full Payment Before Suppliers and Employees?

It is not accurate to say that a bank always receives its full dues before all other parties. Priority depends on the nature of the debt and the security involved, not simply on whether the creditor is a bank.

If a bank holds valid and enforceable in-kind security over one of the company’s assets, it may recover its debt from the proceeds of that asset according to its priority and the applicable legal requirements.

However, if the financing is not secured by in-kind security, it should not automatically be assumed to rank ahead of all other creditors merely because the financing institution is a bank.

Similarly, if the debt exceeds the value of the secured asset, the portion not covered by the sale proceeds is treated as an unsecured debt under Article 197 of the Bankruptcy Law.

This highlights the importance of reviewing the financing agreement, mortgage documents, security registration, asset value, and any other rights associated with the asset before determining the amount that may be recovered with priority.

Sixth: What Are Suppliers’ Rights When a Distressed Company Is Liquidated?

Suppliers are among the parties most likely to be affected by corporate financial distress, particularly when their business depends on supplying products or providing services on credit.

When liquidation proceedings commence, suppliers should not rely solely on informal payment requests or internal account statements. Instead, they should prepare a complete file establishing the origin, value, and due date of the debt.

The most important documents that can help suppliers substantiate their claims include:

Contracts and agreements signed with the company.
Purchase and supply orders.
Tax or commercial invoices.
Delivery and receipt reports.
Delivery notices or transportation documents.
Account statements and financial reconciliations.
Correspondence containing acknowledgments of outstanding amounts.
Receipts or bank transfers showing the amounts paid and the remaining balance.

These documents help establish the contractual relationship, the amount owed, the payment due date, and whether any objections have been raised regarding the goods, services, or invoices.

Suppliers should also verify whether they hold independent security or an in-kind right over a specific asset, as this may affect the priority of their claims compared with unsecured commercial debts.

Seventh: How Can Employees Protect Their Rights During Company Liquidation?

Delayed salaries or a company’s failure to pay employee entitlements do not mean that employees’ rights are forfeited.

The Bankruptcy Law grants wages priority within the debt distribution order, while distinguishing between an amount equivalent to thirty days’ wages and other outstanding wages.

To protect their rights, employees should retain documents proving their employment relationship, salary, and outstanding payment periods. These include:

Employment contracts or other evidence of the contractual relationship.
Payroll records.
Bank statements.
Salary transfer notifications.
Attendance records, where necessary.
Termination or resignation decisions, if applicable.
Any correspondence in which the company acknowledges outstanding amounts.

Employees should avoid signing a final settlement or acknowledgment confirming receipt of all their entitlements if they have not actually received them. They should also review any documents submitted before approving or signing them.

In addition, employees should monitor announcements and notices relating to bankruptcy proceedings and ensure that their claims are submitted using the required method and within the specified deadline, rather than waiting until the distribution process has ended.

Eighth: How Can a Creditor Submit a Claim During Liquidation Proceedings?

Submitting a claim is an essential step that enables a creditor to establish their rights and participate in the distribution according to the applicable priority.

Procedural details vary depending on the type of bankruptcy proceeding. However, the main practical steps can be summarized as follows:

1. Verify That Liquidation Proceedings Have Commenced

The creditor must confirm that the company has officially entered liquidation proceedings under the Bankruptcy Law, identify the competent court and the appointed trustee, and review the announcements associated with the proceedings.

A company’s suspension of payments or closure of its premises does not necessarily mean that liquidation proceedings have officially commenced.

2. Review the Proceedings Announcement and Claim Submission Deadlines

The creditor should review the official announcement concerning the proceedings and verify the deadlines and instructions for submitting claims and supporting documents.

Creditors should not rely on unofficial information or deadlines circulated among other creditors, as each procedure has its own requirements and stages.

3. Prepare a Clear Statement of the Debt

The claim amount must be accurately identified, including the original debt, the date it arose, its due date, the amounts already paid, and the remaining balance owed by the company.

If the claim includes additional amounts, compensation, or contractual interest, the legal basis for each amount and its permissibility under the applicable law must be clarified. Amounts that are not due or cannot be substantiated should not be included.

4. Attach Supporting Documents

Contracts, invoices, correspondence, delivery reports, account statements, and other evidence supporting the claim should be attached.

If the debt is secured, the creditor should also submit the security documents and evidence of its registration or enforceability, as required by law.

5. Follow Up on the Status of the Claim

The creditor’s responsibility does not end after submitting the documents. They should follow up to determine whether the claim has been accepted, challenged, or returned for additional information.

If a dispute arises regarding the origin or amount of the debt or its priority, it should be addressed through the legal procedures available.

Ninth: Can a Creditor Object to the Decision to Distribute Assets?

Yes. The Bankruptcy Law grants creditors the right to object to a decision concerning the distribution of proceeds from the sale of bankruptcy estate assets, or to the procedures associated with that distribution, subject to specific requirements and deadlines.

Under Article 116 of the Bankruptcy Law:

The trustee must notify every known creditor of the distribution decision and provide a copy at least thirty days before the scheduled distribution date.
A creditor may file an objection with the court within twenty-one days from the date of notification.
The trustee must suspend distribution until the objection has been resolved.
The court considers the objection and issues its decision, while completing the distribution procedures, within twenty days of its submission.

These provisions are particularly important when a creditor discovers an error in the approved claim amount, the priority ranking, the amount allocated to them, or the procedures followed when preparing the distribution decision.

Therefore, the distribution decision should be reviewed immediately upon receipt. Creditors should not wait until the statutory objection period expires, as missing the deadline may affect their ability to address the error through this procedure.

Tenth: Can a Company Director Be Held Liable for Harming Creditors Before Liquidation?

As a general rule, a company has its own legal personality and independent financial liability, separate from those of its partners and directors. Therefore, a director does not become personally responsible for the company’s debts merely because the company becomes financially distressed or enters liquidation.

However, this principle does not provide directors with absolute protection regardless of their actions.

Legal liability may arise when prohibited actions are committed that harm creditors, such as misusing company assets, concealing them, transferring them without fair consideration, paying one creditor in a manner that harms other creditors, or conducting business with the intention of defrauding creditors.

Article 200 of the Bankruptcy Law addresses certain acts that constitute violations of its provisions when committed by the debtor, its director, an officer, or a person in a similar position, and result in the commencement of bankruptcy proceedings or harm the rights of relevant parties.

These acts include the misuse of assets, entering into transactions without consideration or for unfair consideration, and paying certain creditors in a manner that harms other creditors.

This means that assessing a director’s liability does not depend merely on the existence of losses or unpaid debts. It requires examining the actions taken, the available evidence, the resulting harm, the connection between the conduct and the outcome, and the application of the relevant legal provisions.

Eleventh: Common Mistakes Creditors Make During Company Liquidation

A creditor may have a valid claim but weaken their position through procedural mistakes or insufficient documentation. Some of the most common mistakes include:

1. Delaying Claim Submission

Delays may result in missing deadlines or complicating the process of establishing the debt. Creditors should therefore monitor official announcements as soon as they become aware that proceedings have commenced.

2. Relying on Invoices Alone

An invoice may be important, but it is not always sufficient to establish every detail of a claim, particularly when there is a dispute regarding delivery, service quality, or the outstanding balance.

3. Failing to Verify Whether Security Exists

A creditor may hold a secured right over a specific asset but fail to submit the security documents or clarify its scope, which may affect the determination of the debt’s priority.

4. Confusing Ordinary Liquidation with Liquidation Under the Bankruptcy Law

Each procedure has its own legal provisions. The priority order applicable to bankruptcy liquidation should not be applied to every liquidation without first identifying the legal framework governing the case.

5. Ignoring the Distribution Decision

Failing to review the decision may result in losing the opportunity to object within the legally specified period.

6. Entering into Undocumented Settlements

Verbal agreements or unclear settlement documents may create disputes regarding the amount owed or the payments already made. Any settlement or payment should therefore be documented clearly.

7. Assuming That Debt Priority Guarantees Full Repayment

Priority determines the order in which debts are settled, but it does not guarantee that sufficient assets will be available to cover the entire amount. A creditor may receive only part of their entitlement, depending on the available proceeds and their priority level.

Twelfth: How Can Legal Consultation Help Protect Creditors’ Rights?

The liquidation of a distressed company is not simply a matter of selling assets and paying invoices. It is a legal and financial procedure that requires careful examination of claims, security interests, contracts, documents, and decisions issued throughout the proceedings.

A specialized lawyer can assist creditors in several important areas, including:

Reviewing contracts and documents and identifying the legal basis of the claim.
Examining in-kind security and determining the scope of the rights associated with it.
Preparing clear, well-documented financial claims.
Monitoring liquidation proceedings, official announcements, and statutory deadlines.
Reviewing decisions concerning the distribution of asset sale proceeds.
Assessing the legal grounds for objecting to distribution decisions.
Examining actions that may have harmed creditors’ rights.
Advising on the legal options available for recovering outstanding amounts.

Early legal consultation may also help companies understand their obligations before reaching a stage where their assets are insufficient to cover their debts, and avoid actions that could expose the company or its management to additional liability.

Frequently Asked Questions About the Liquidation of Distressed Companies and Debt Distribution

Who Has Priority in Debt Recovery When a Company Is Liquidated?

In liquidation proceedings under the Bankruptcy Law, the bankruptcy trustee’s fees and expenses, expert fees, and asset sale costs are paid before distribution. The remaining proceeds are then distributed according to the priority categories established under Article 196, beginning with debts secured by in-kind security, followed by the other categories specified by law.

Does a Supplier Receive Payment Before a Bank?

Not necessarily. If a bank holds a valid debt secured by in-kind security, it may have priority in recovering its debt from the proceeds of the secured asset. A supplier holding an unsecured debt, on the other hand, generally falls within the unsecured debt category, subject to the applicable legal provisions.

Are Employees’ Rights Lost When a Company Becomes Bankrupt?

No. Employees’ rights are not forfeited merely because liquidation proceedings commence. The Bankruptcy Law grants wages priority within the debt distribution order, distinguishing between an amount equivalent to thirty days’ wages and other outstanding wages, in accordance with the applicable legal provisions.

What Happens If the Company’s Assets Are Insufficient to Pay Its Debts?

The proceeds are distributed according to the established order of priority. If the available amount is insufficient to settle debts of equal priority, it is distributed among those creditors on a pro rata basis, according to the value of each creditor’s claim in relation to the total claims within the same category.

Can a Creditor Object to the Distribution of Company Assets?

Yes. A creditor may object to a decision concerning the distribution of proceeds from the sale of bankruptcy estate assets, or to the related procedures, before the court within twenty-one days from the date of notification, in accordance with Article 116 of the Bankruptcy Law.

Is a Partner Personally Responsible for the Company’s Debts After Liquidation?

As a general rule, a company has an independent financial liability, and a partner is not personally responsible for its debts merely because of their status as a partner. However, the company’s legal structure, personal guarantees, independent obligations, and any liability arising from specific violations or actions must also be considered.

Can Company Assets Be Sold Before All Creditors Have Been Paid?

Assets may be sold during liquidation proceedings to convert them into cash. However, the proceeds must be distributed according to the applicable legal procedures and priority rules, while taking into account rights associated with the assets, security interests, objections, and outstanding claims.

Conclusion

Determining creditor priorities during the liquidation of distressed companies is one of the most important matters directly affecting creditors’ ability to recover their outstanding dues.

The existence of an established debt does not necessarily guarantee full repayment. Likewise, the presence of security or a statutory priority may make a significant difference in the order of recovery.

Therefore, creditors should act early, prepare their supporting documents, verify the nature of their claims and any associated security, and monitor liquidation proceedings and asset distribution decisions within the specified deadlines.

Companies and their management must also address financial distress through the correct legal procedures and avoid actions that may harm creditors’ rights or result in additional liability.

Suleiman Al-Omari Law Firm – Lawyers and Legal and Sharia Consultants

The firm provides legal consultation and representation services for companies and creditors in commercial disputes and financial claims. Its services also include reviewing liquidation and bankruptcy proceedings and examining security interests and contractual obligations, helping protect commercial rights and interests in accordance with the laws and regulations applicable in the Kingdom of Saudi Arabia.

📞 Contact: +966537778130

This article is intended for general educational purposes and does not constitute a substitute for specialized legal advice.