The Search for Someone to Save: A Defensive Case for the Priority of Secured Credit

Abstract

The priority of secured credit has repeatedly and famously been attacked for allowing the exploitation of certain types of unsecured creditor. It has also been blamed for creating inefficiencies. This paper examines these arguments specifically as applied to the UK, and using both theoretical analysis and recent empirical data, suggests none of them can be sustained. It is argued that security is unlikely to lead to the exploitation of involuntary, "uninformed", or "unsophisticated" creditors, since the perverse incentives it allegedly creates for the debtor's management are likely to be outweighed by the managers' liquidation-related costs. It is then pointed out that both exploitation-based and inefficiency-based attack on the priority of secured credit depend on the assumption that secured credit is generally cheaper than unsecured credit, and further, that this is why debtors prefer to borrow on a secured rather than unsecured basis. Recent evidence from the UK (hereafter, "this jurisdiction") is used to challenge this assumption. This has dramatic implications for the attacks on security, which are discussed. The paper concludes with the demonstration that secured credit, by inducing creditors to lend when they would not do so without being offered priority, is mutually value-enhancing for all types of creditor, including unsecured ones.

JEL Classification: D23, K19, K22, K39