An insolvent liquidation procedure involves the sale of assets and distribution of the proceeds amongst company creditors. An insolvency practitioner is appointed to administer the process, and must ensure that all creditors are paid according to the hierarchy laid down in the Insolvency Act 1986.
Here, we explain the ‘hierarchy’ and why unsecured creditors often fare badly in liquidation procedures. Each class of creditor must be paid in full before funds are allocated to the next.
What factors influence creditor repayment in liquidation?
There are several factors that influence the hierarchy of repayments in Company Liquidation. A general outline of the criteria are listed below.
Secured or unsecured status
A secured creditor is directly tied to an asset or investment that holds security, or lien, against a debtor’s property. This lien is often agreed upon at the time of the debt being taken out and is most often held as collateral in the asset purchased.
Unsecured creditors have outstanding loans with the debtor. However, their agreements do not entitle them to a lien or a right to claim the assets of the debtor. Unsecured creditors include credit card companies, as well as some cash in advance companies.
You can learn more about the difference between secured and unsecured creditors in our dedicated blog post.
Timing of the secured status
A lien is a legal right placed on an asset which is often used as collateral to secure debt. Problems may arise when a single asset is used as collateral to secure more than one line of credit. This means more than one lender could potentially own a secured claim against a single asset.
To avoid this, collateral pledged to secure financing is noted as either a first lien or a second lien. A first lien has high priority on the collateral. The general rule is that the first creditor to secure a lien, receives priority. Although this is not always the case, whichever creditor secured the initial lien is more likely to be granted the first lien.
A preferred creditor is an individual associated with the debtor who is given some priority during the liquidation process. These creditors may not have held rights to claim assets, but they are given preferential treatment during liquidation proceedings.
Preferred creditors may be considered to be a special type of unsecured creditor, and examples include:
- Company employees
- Tax agencies
- Environmental claims
- Tort victims (civil court cases, such as payment of medical expenses and loss of income)
What are priority creditors?
Priority creditors are individuals or organisations that have a legal priority during the liquidation process.
Due to the nature of the relationship with the insolvent party, and potential legal claims they may have over the assets, some parties are entitled to receive proceeds before others.
The most common types of priority creditors include alimony, tax obligations, child support or liabilities for injury or death.
Why are secured creditors paid first in Liquidation?
Secured creditors are paid first as they are usually those who have security over some or all of the company assets. The secured creditor will take back the property they’ve secured, or will be entitled to the proceeds from the liquidation of that specific property.
Examples of secured creditors include banks, leasing companies and other lenders.
Creditors can have a legal right over company property, which can include assets such as property, machinery, vehicles and intellectual property.
How are creditors ranked in Liquidation?
Creditors are ranked as follows:
- Liquidator fees and expenses
- Secured creditors with a fixed charge
- Preferential creditors
- Secured creditors with a floating charge
- Unsecured creditors
- Connected unsecured creditors
Liquidator fees and expenses
The liquidator’s remuneration and fees for administering the process are first to be paid.
Administrative costs and expenses can be incurred for holding meetings, realising assets, distributing funds, providing accounts and reports and investigating the conduct of directors.
Secured creditors with a fixed charge
This creditor group includes banks and other financial institutions that have provided borrowing to the company, taking security on one or more business assets.
For example, if the company has borrowed money to purchase land or property, the bank will take fixed charge security allowing them to sell the asset on default or liquidation, and thereby recoup their money.
Preferential creditors and ‘prescribed part creditors’
Preferential creditors are members of staff entitled to certain statutory payments. These include arrears of wages, holiday pay, redundancy, and unpaid pension contributions.
The ‘prescribed part’ refers to an amount set aside from the sale of assets with a floating charge taken out after 15th September 2003. This sum is used to provide unsecured creditors with a greater chance of recovering part of their debt.
50% of the first £10k released from the sale of floating charge assets is set aside in this way, and then 20% of any realisations between £10k and £600k. Anything left goes towards repaying floating charge-holders.
Secured creditors with a floating charge
Assets subject to a floating charge can include stock, raw materials, work-in-progress, fixtures and fittings – essentially, any other assets not subject to a fixed charge. Assets of this type can be traded in the normal course of business.
Terms and conditions relating to fixed and floating charges are laid out in a debenture – a document signed by the directors and registered by the creditor at Companies House.
Unsecured creditors generally consist of the company’s customers, suppliers, contractors, certain employee claims and HMRC.
If all unsecured creditors have received an equal dividend and there are additional funds available, interest is also paid on their debt.
Connected unsecured creditors
Unsecured creditors who have an association with the company are eligible to be paid a dividend upon liquidation.
This creditor group could include a director’s family member, or an employee who has loaned money to the business. Employee expenses also fall into this category.
Shareholders are the final group to be paid. As they have taken a business risk in providing money to the company, they are not entitled to a distribution until all other creditor groups have been paid.
In an insolvent liquidation, it is unlikely that there will be sufficient funds to pay this class of creditor.
How are assets distributed in Company Liquidation?
All classes of creditor must be paid in full before the liquidator can distribute funds to the next group, and it is important to maximise the interests of creditors once you enter an insolvency process such as a company liquidation.
Otherwise, as a director, you could be subject to accusations of wrongful or unlawful trading. Fixed and floating charges are a complex area to understand, particularly if more than one charge has been taken on an asset.
The Insolvency Experts can help clarify your company’s financial position, and investigate who takes priority in cases where you have multiple creditors.