When a business is insolvent, there are some creditors who are higher in the payment priority hierarchy, hence the term ‘preferential’.
While ‘preferential’ may sound like it qualifies as top priority this is not the case, however, as we’ll explain below.
What are Preferential Creditors
A preferred creditor is one that ranks higher than other unsecured creditors, in UK law. They also rank (in corporate insolvencies) above floating charge holders and the prescribed part (Schedule 6 and sections 175, 176, 328, 347 and 386, Insolvency Act 1986)..
These creditors are secondary however, to those who are ‘secured’, which are typically banks and other finance providers with a fixed charge, such as property, and that is registered at Companies House.
Priority of Creditors
This can be shown as follows:
• Liquidation fees and charges
• Secured creditors with fixed charges
• Preferential creditors
• Creditors holding floating charges
• Unsecured creditors
• Any interest payable on debts
What are Examples of Preferential Creditors?
The largest group of preferential creditors are often employees. Although at the start of liquidation, employees will be dismissed from the company, they can potentially receive any unpaid wages up to a maximum of £800, along with any pension scheme contributions and holiday pay entitlements that are due.
Meanwhile, in the event of an employer not properly consulting prior to dismissing employees as redundant, then an Employment Tribunal may make a so-called ‘Protective Award’ to that individual and this would be seen as a preferential payment.
Another category of preferential creditors are tort victims. These are individuals who have taken out legal action against the company and had damages awarded – as such, they will be viewed as priorities by the liquidator.
Finally, if the company is a polluter, it is possible this will also be an increasing influence in terms of assessing creditor status. In the legal case, Ratten v Natural Resource Body for Wales from 2019, the judge ruled that paying for the clean up costs to remedy damage, as served under environmental notices, should take priority over other claims to assets, including those of secured creditors.
Is HMRC now a Preferential Creditor?
The Finance Act of 2020 introduced a significant change with HMRC being designated as a secondary preferential creditor so that more tax could be collected from insolvent companies and individuals – this came into place from 1 December 2020.
HMRC had previously been in this position pre 2002 but a change in the law then meant it was re-classified as an unsecured creditor and often did not receive proceeds from asset sales. It is often one of the largest creditors in an insolvency and is now in a stronger position to recoup some larger debts, which would be from VAT, PAYE, National Insurance Contributions and Construction Industry Scheme deductions. Meanwhile for corporation tax and any other taxes owed directly by a company, HMRC will remain classed as an unsecured creditor.
The fact that HMRC has moved up the ‘pecking order’ is potentially bad news for unsecured creditors, since there may well be few if any proceeds remaining. However, the counter argument to this is that if HMRC is able to recoup more, then these monies can be redistributed to benefit the public at large by funding services.
HMRC now takes precedence over creditors with floating charges and these would often be financial institutions and lenders holding asset backed debt.
FSCS Depositors are Preferred Creditors
Since 2015, when the Banks and Building Societies Order came into force, those who had deposited their money with insolvent members of the Financial Services Compensation Scheme became entitled to recompense, providing the amount does not exceed the scheme’s £85,000 cap.
Like HMRC, FSCS depositors are known as secondary preferential creditors and they are paid after the ordinary preferential debts.