Which Creditors Get Paid First During Insolvency?
If you’re the owner of an insolvent company that’s entering an administration or a company liquidation, it’s only natural that you’ll want to understand more about the pecking order that applies to the payment of your creditors. For example, where do HMRC and the bank rank? Will your employees rank ahead of company employees if the bank has security?
The best way to answer these questions is to think of creditor payment priority as a ladder. At the top, you have the insolvency practitioner, who receives a fee for overseeing the process, and any creditors to whom the company granted security i.e. banks and finance providers. At the bottom of the pile are the shareholders, and just above them, the unsecured creditors.
Rights of Secured Creditors during Liquidation
At the top of the creditor priority list come the company’s secured creditors, who hold a fixed or floating charge over a business asset. They have a legal right or charge over company property, which can include anything from buildings and equipment to vehicles, machinery and intellectual property. Examples of secured creditors include leasing companies, banks and other lenders. Once the insolvency practitioner has received their fee, the secured creditors are next to receive the money they are owed.
- A fixed charge is held over a specific asset which was financed by the lender. That includes business premises, intangible assets, financed vehicles and financed machinery. The fixed charge will be registered at Companies House. Those with a fixed charge one of the first to be paid from the liquidation after the insolvency practitioner has received their fee.
- A floating charge relates to the other company’s assets including cash at bank, fixtures and fittings, unencumbered plant and machinery and book debts when there is no invoice factoring agreement. Floating charge holders are placed further down the hierarchy of payment after preferential creditors (i.e. the former employees) have been paid.
It is not uncommon for a bank or asset-based lender to have both fixed and floating charges registered at Companies House.
Fixed Charge Creditors
A fixed charge is a direct charge over a specific asset, or category of assets, which means the company is not free to sell or trade the asset without the permission of the charge holder i.e. a bank or other lender. Most commonly a fixed charge will apply to a piece of machinery.
This is the case because the machinery in question is often central to the output of the company, so it would be unusual for such a piece of machinery to be sold. If the company does wish to sell the machinery (because it’s no longer efficient etc.) the company would have to seek permission from the charge holder. This will typically be granted as the proceeds from the sale could be used to repay the company’s borrowings.
Floating Charge Creditors
The situation with floating charges is not quite so simple. Floating charges give a greater degree of flexibility to the company and the creditor. The creditor is free to administer its assets in the normal course of its business, with the charge only kicking in when a ‘crystallising event’ takes place, such as the company becoming insolvent.
Under any floating charge created after 15 September 2003, 50 percent of any money realised up to the value of £10,000 must be set aside for the company’s unsecured creditors. 20 percent of any amount between £10,000 and £600,000 must be paid to unsecured creditors, with the rest going to the holder of the floating charge.
The insolvency regime changed in 2002 under the Enterprise Act, and HMRC was no longer classed as a preferential creditor. HMRC now ranks alongside unsecured creditors, which will result in lower returns for the Crown but will increase the insolvency returns for trade creditors. Employees are classed as preferential creditors for unpaid wages and holiday pay claims, so they are next in line to receive their cut.
HMRC is just one of the creditors that fall within the list of unsecured creditors. This group will include VAT payments, suppliers, trade creditors, business rates and claims other than pay arrears and holiday pay by employees.
Unsecured Creditors Connected to the Business
If a director or employee lends the company money on an unsecured basis, or salaries and wages for company owners and directors are unpaid, they will become ‘associate creditors’ i.e. the creditor is in some way associated with the company. This can also include money borrowed from family members. Generally speaking, associate creditors will not typically receive a repayment in a voluntary company arrangement (CVA) or liquidation.
Right at the very bottom of the pile are the company shareholders. These are the people who have invested money in the business on a risk basis, and as such, they are not entitled to remuneration or repayments in a company liquidation or administration until the claims of all of the above groups are satisfied.
Do you need help?
Determining who gets paid in a company insolvency can be a very complex area, particularly in the case of floating charge and associate creditors. If you need help understanding your position, you should seek advice at your earliest opportunity. Please call 08000 746 757 for a no-obligation initial consultation, or complete an enquiry form and one of our company rescue advisers will be in touch.