There are three types of creditor in the UK – secured, preferential and unsecured – and their priority in terms of payment when a business is liquidated is laid down in the Insolvency Act 1986.
In this article, we’ll define the role of a creditor in depth.
What is a Creditor?
In simple terms, a creditor is a person or a business to whom money is owing. Whether it is a large bank or an individual, creditors have a number of powers that are defined in law and by which they can seek to secure payment.
What’s the Difference Between Secured, Preferential and Unsecured Creditors?
It’s important that business owners understand the differences between the three main types, since there is always a priority of creditors denoting which should be paid first.
A secured creditor will usually be a large financial institution such as a bank, building society or invoice factoring company. They hold a ‘charge’ over the company they are seeking payment from, such as property. The charge needs to be registered with Companies House and this ensures the asset cannot be disposed of unless this is permitted by the secured creditor.
Secured debt usually comes with better terms compared to unsecured debt, because for the lender, the risks are lower. Secured creditors are paid first in a liquidation and they have most authority. In some cases, they are able to appoint an administrator if there are serious concerns about viability.
Next in line in terms of their priority are preferred creditors and they are typically employees. It should be noted that HM Revenue and Customs is also classed as a preferential creditor as are tort victims, namely those who have taken legal action against the business owing money for wrongful action.
A change in the law, via the Banks and Building Societies Order 2014, means that depositors protected by the Financial Services Compensation Scheme are also now categorised as preferred creditors.
Unsecured creditors are last in terms of priority in the event of insolvency and if they do gain a payout, it will often be smaller than secured and preferential creditors. Unsecured creditors cover a wide remit of contractors, suppliers and customers.
Because they have less security of payment, unsecured creditors are in a more precarious position.
Where do Shareholders Stand as Creditors?
Company shareholders are the final grouping and are not classified as secured, preferential or unsecured creditors. Shareholders will only receive proceeds if there are any funds available after other creditors have been paid.
What Happens if Creditors Don’t Get Paid?
Not paying creditors is the classic trigger for an insolvency event such as a winding up petition. Creditors will first use formal letters such as a Statutory Demand, and then escalate to a Winding up Petition, which is the most serious threat any limited company can face. If you don’t respond to this, a judge may make a Winding up Order which will push your company into compulsory liquidation after which it will be permanently closed.
Insolvency Act 1986, Section 239, Preferences: https://www.legislation.gov.uk/ukpga/1986/45/section/239