In the world of finance, senior debt refers to any type of outstanding obligation that takes precedence over any other debts currently owed. Since senior debt is usually secured with some type of collateral, this means that the issuer of this debt will receive payments before issuers of any unsecured debt are paid. Companies of all types tend to use this type of debt as a means of prioritizing its financial obligations in the most efficient fashion.
There are many examples of senior debt. One has to do with the imposition of a first lien. In the event that a lien is established against the assets owned by a company, the lien holder has first claim on those assets. The collateral cannot be sold for any purpose other than settling the debt connected with the lien. Once the debt is settled, any funds remaining from the sale of the collateral can be used by the owner in any manner he or she wishes.
Senior debt is a concept that is also helpful in situations where a business goes into bankruptcy. Essentially, the designation of a debt as being senior means that when assets are liquidated to settle at least a portion of the outstanding debt of the company, that particular debt will be addressed first. Usually, the court overseeing the bankruptcy proceedings must approve the final plan for restructuring and paying off all debts, but will require that the plan is focused on eliminating senior debt before any subordinate types of debt are settled.
In situations where the pledged collateral proves to not sell for enough funds to settle the senior debt, creditors have the option of attempting to gain control of other assets owned by the debtor, or simply writing off the remaining balance due. Depending on the total amount that remains outstanding, some creditors will choose the latter option, especially if the costs of pursuing full settlement of the debt will cause the creditor to incur more expenses than the total amount of the remaining debt. In cases where the remaining balance of the debt is substantial, it is highly likely that the creditor will make use of all legal means to secure the full payment necessary to settle the debt.
Businesses develop different strategies for managing senior debt. Some choose to set aside resources in a senior debt fund, effectively allocating cash and other assets that can be used to pay on the debt in the event of an economic downturn. Others make us of a senior debt rating system that makes it possible to internally prioritize all debts in this class, essentially establishing the schedule for making regular payments and eventually retiring each debt. The exact processes used by a given company will often depend on the regulations and standards that hold sway in the country where the business is incorporated and primarily conducts its business.
