Assets are distributed based on the priority of various parties’ claims, with a trustee appointed by the Department of Justice overseeing the process. The most senior claims belong to secured creditors, who have collateral on loans to the business. These lenders will seize the collateral and sell it—often at a significant discount, due to the short time frames involved. If that does not cover the debt, they will recoup the balance from the company’s remaining liquid assets, if any.
Next in line are unsecured creditors. These include bondholders, the government (if it is owed taxes) and employees (if they are owed unpaid wages or other obligations). Finally, shareholders receive any remaining assets, in the unlikely event that there are any. In such cases, investors in preferred stock have priority over holders of common stock.
Liquidation can also refer to the process of selling off inventory, usually at steep discounts. It is not necessary to file for bankruptcy to liquidate inventory.