Priorities clause: Overview, definition, and example
What is a priorities clause?
A priorities clause is a provision in a contract that establishes the order in which obligations, claims, or debts will be paid or satisfied in the event of a dispute, liquidation, or insolvency. It clarifies which parties or creditors have the highest priority when it comes to receiving payments or assets, and it helps avoid conflicts over competing claims. In essence, this clause dictates the sequence of payments or actions to be taken, ensuring a structured and predictable resolution in case of financial distress.
For example, in a loan agreement, a priorities clause might specify that senior creditors must be paid first, followed by subordinated creditors if any funds remain.
Why is a priorities clause important?
A priorities clause is important because it provides clarity and certainty to all parties involved regarding the order of claims, especially in situations where there may be insufficient resources to satisfy all obligations. This clause is particularly critical in financing agreements, joint ventures, and corporate restructuring, where multiple creditors or stakeholders are involved, and there may be competition for limited assets.
For businesses, having a clear priorities clause helps manage risk and can influence decisions in negotiations, such as offering security or guaranteeing payment. It can also help avoid disputes between creditors or stakeholders and provide a clear framework for resolving financial issues.
Understanding a priorities clause through an example
Imagine a company in financial distress and undergoing liquidation. The company owes money to multiple creditors, including a senior lender, suppliers, and subordinated bondholders. The priorities clause in the company’s loan agreement specifies that the senior lender gets paid first from any available assets, followed by the suppliers, and lastly, the subordinated bondholders, who only receive payment if there are remaining funds. This ensures that the creditors understand in what order their claims will be settled.
Another example could be a joint venture where the parties agree that in the event of a disagreement or a financial issue, one party's claims will take precedence over others. This helps avoid confusion and ensures that the preferred party will be paid first in case of liquidation or asset distribution.
An example of a priorities clause
Here’s how a priorities clause might appear in a contract:
“In the event of liquidation, bankruptcy, or sale of the company’s assets, the order of payment will be as follows: (i) first, all outstanding debts owed to senior creditors shall be paid in full; (ii) second, payments will be made to junior creditors; and (iii) any remaining funds will be distributed to equity holders.”
Conclusion
A priorities clause establishes the order of payments or claims in case of insolvency, liquidation, or dispute, providing a clear structure for how resources will be distributed among creditors or stakeholders. This clause is essential for managing risk and ensuring fairness in financial dealings. For businesses and creditors alike, having a clearly defined priorities clause helps avoid disputes and ensures that the most important obligations are settled first, providing predictability and legal clarity in financial matters.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.