When a company enters insolvency and has to be liquidated, the order in which creditors are paid is defined by the Insolvency Act, 1986. This ‘hierarchy’ is divided into classes of creditor, and each class or group must be paid in full before the liquidator moves on to the next.
There are essentially three main categories – secured, unsecured, and preferential creditors – but these can be broken down further as we detail below.
Once the costs of liquidation have been covered, the first class of creditor to be paid are secured creditors with a fixed charge. At the bottom of this ranking lie unsecured creditors, who unfortunately, rarely fare well in these situations in terms of repayment.
Other factors also influence how much is received by each creditor class, including the cost of the liquidation process, the number of assets available for sale, and the ease with which they can be realised.
Secured creditors are generally banks and asset-based lenders with security in the form of a mortgage on business premises, land, or a specific piece of machinery. Secured creditors could also include invoice factors holding security over a company’s sales ledger. When a company goes into liquidation, the secured fixed charge creditor is able to sell the asset in question to recover their money.
Preferential creditors include employees who are owed arrears of wages and holiday pay up to certain limits, and outstanding pension contributions. HMRC no longer fall into the category of preferential creditor, and since 2003 have been classed as an unsecured creditor.
Floating charges are those held over asset classes, such as fixtures and fittings, stock, and raw materials – essentially these assets can be traded as normal, unlike a fixed charge which is held on a particular item.
The prescribed part is an amount set aside from the sale of assets with a floating charge that has been taken out after 15th September 2003. This is for the benefit of unsecured creditors, to boost their chances of receiving a return from the liquidation. The prescribed part is calculated as 50% of the first £10,000 of floating charge asset realisations, and 20% of any between £10,000 and £600,000.
This group consists of creditors who aren’t classed as secured or preferential, and include trade suppliers, contractors, some employment-related payments, HMRC, suppliers, and customers.
Also known as ‘associate’ creditors, connected unsecured creditors can include spouses and other members of a director’s family, or perhaps a member of staff who has loaned money to the company on an unsecured basis.
If there are sufficient funds to pay shareholders from the process, it will be regarded as a solvent liquidation. It’s recognised that shareholders take a risk when investing in a company, and they don’t receive a dividend from insolvent liquidations unless they hold some form of security over the company.
For more information on the order of creditors in liquidation, call one of our expert team. Real Business Rescue can advise on your position within the hierarchy, and of the likelihood of receiving a dividend from the liquidation. We offer a free same-day meeting, We have an extensive network of 78 offices offering confidential director support across the UK.