Is Full Preference for a Secured Claim in Insolvency Proceedings Justified?

Abstract

Secured claims have priority over other claims in the event of debtor insolvency with respect to the distribution of the debtor’s encumbered assets. Numerous writings have discussed the necessity of security instruments in the context of growth and development of the economy. Credit is indeed necessary for the economy’s development, but, at the same time, credit is the cause of insolvency. This can be put another way: efficient credit develops the economy, while inefficient credit causes insolvency. The author argues on this basis that restriction of the secured creditor’s rights in insolvency proceedings means not less credit but more effective credit. A security-holder whose rights are limited is going to lend more responsibly and monitor the activity of the debtor more intensively and effectively, because the risk of loss would otherwise increase. Better monitoring should lead also to earlier intervention by the secured creditor in the actions of the debtor, which can be expected to increase the number of cases of rescue of debtors headed for insolvency. The author suggests the option of removing a small amount from the secured creditor and distributing it among the unsecured creditors to make the credit system more efficient and reduce injustice. Implementing this option would not harm the interests of the secured creditor as much as it helps to render the whole system more efficient.