Understanding the Order of Payment Priority During Company Liquidation

Liquidation can be a complex and distressing process for businesses and their creditors. When a company is liquidated, its assets are sold off to repay debts, but not all creditors are treated equally.

The order in which creditors are paid is governed by a strict hierarchy defined by the Insolvency Act 1986. This blog aims to clarify the order of payment priority in company liquidation, helping creditors understand their position and what to expect.

Who Are Creditors in Liquidation?

Creditors are individuals or businesses owed money by a company. In the event of liquidation, these debts are addressed according to a statutory hierarchy.

Unfortunately, due to the fundamental lack of cash that characterises insolvency, some creditors may receive little or no repayment. The liquidator, appointed to manage the liquidation process, is responsible for distributing funds according to this hierarchy.

The Creditor Hierarchy in Liquidation

When a company enters insolvent liquidation, creditors are grouped into categories that determine the order of repayment. The main categories are:

1. Liquidation Fees and Expenses
2. Secured Creditors with a Fixed Charge
3. Preferential Creditors
4. Secured Creditors with a Floating Charge
5. Unsecured Creditors
6. Connected Unsecured Creditors
7. Shareholders

Each category must be paid in full before the liquidator can move on to the next. Let’s take a closer look at each group.

1. Liquidation Fees and Expenses

The costs of administering the liquidation process are the first to be covered. These include the liquidator’s fees, expenses for realising assets, holding meetings, distributing funds, and other necessary administrative costs.

2. Secured Creditors with a Fixed Charge

Secured creditors with a fixed charge are typically banks or asset-based lenders with a claim on specific assets such as property, vehicles, or machinery.

These assets are pledged as security for loans, and the fixed charge is registered with Companies House. In the event of insolvency, these creditors have the right to seize and sell the asset to recover their money.

3. Preferential Creditors

Preferential creditors mainly include employees owed certain statutory payments such as unpaid wages and holiday pay.

However, not all employee claims are preferential; for instance, redundancy pay and notice pay are classified as unsecured claims.

4. Secured Creditors with a Floating Charge

Creditors holding a floating charge are next in line. Floating charges cover classes of assets like stock, raw materials, and work-in-progress. When a company becomes insolvent, the floating charge crystallises, becoming a fixed charge over these assets.

A portion of the proceeds from these assets, known as the 'prescribed part', is set aside to improve the chances of unsecured creditors receiving a return.

5. Unsecured Creditors

Unsecured creditors, including suppliers, customers, contractors, and clients, must file claims for their debts.

Unfortunately, it is common for unsecured creditors to receive no payment, as they are last in line after secured and preferential creditors.

6. Connected Unsecured Creditors

This group includes individuals with a personal connection to the company, such as family members or friends of the directors, who are owed money.

They are only paid once all other unsecured creditors have received their share.

7. Shareholders

Shareholders are at the bottom of the priority list. They are unlikely to receive any return in an insolvent liquidation since all other creditors must be fully paid before any distribution can be made to them.

The Role of HMRC in the Repayment Hierarchy

Since December 1, 2020, HMRC has gained secondary preferential creditor status for certain taxes. This change means outstanding PAYE, employee NICs, VAT, and Construction Industry Scheme (CIS) payments are prioritised over unsecured creditor claims.

However, taxes owed directly by the company, like corporation tax, remain classified as unsecured debts. This adjustment further reduces the likelihood of unsecured creditors receiving repayments.

Factors Influencing Creditor Repayment

Several factors influence the hierarchy of repayments in company liquidation:

• Secured vs Unsecured Status: Secured creditors have collateral backing their claims, making them a higher priority than unsecured creditors, who do not have such claims on assets.
• Timing of Secured Status: The timing of when a charge is registered can affect priority, with earlier liens generally having precedence over later ones.
• Preferred Status: Preferential creditors receive priority due to their specific relationship with the company, such as employees and tax authorities.

Why Are Secured Creditors Paid First?

Secured creditors are paid first because they have legal claims on specific company assets. These claims are often established through collateral agreements made at the time of lending.

The security of these assets allows secured creditors to reclaim their money through asset liquidation, giving them precedence in repayment.

Conclusion

Understanding the order of payment priority in company liquidation is crucial for creditors to manage their expectations and plan accordingly. The statutory hierarchy aims to ensure a structured and fair distribution of assets.

If you think that liquidation could be the right option for you, our team of professionals are here to support you every step of the way. Whether you’re facing financial challenges or seeking to optimise your business’s resources, we’re committed to helping you find the best solutions tailored to your needs.

Don’t hesitate to reach out to us. Give us a call on 01603 552028 or send an email at [email protected]. Let’s start a conversation and chart a course towards financial recovery together. Your success is our priority, and we’re here to help you overcome any obstacles standing in your way.