Creditors are individuals or businesses owed money by a company. In the event of insolvency and liquidation, if the debts owed are not repaid, any remaining unpaid debts are cancelled. In some cases, due to the shortage of cash, some creditors may not receive any payments even after the company’s assets are sold.
In an insolvent liquidation, creditors are divided into categories based on their priority in payment. This order is determined by the Insolvency Act, 1986 and the liquidator must make payments according to this hierarchy. The payment hierarchy determines which group of creditors is paid first during the liquidation process.
Creditor Categories in Liquidation
At the start of the liquidation process, the fees for the process must be settled. Then, there are three main categories of creditors:
- Secured creditors (with sub-categories of fixed charge holders and floating charge holders)
- Preferential creditors
- Unsecured creditors
The liquidator must fully repay each group before moving on to the next.
Secured creditors with a fixed charge
Secured creditors are typically banks or lenders who have a fixed claim on specific assets, such as vehicles, property, or land. Upon the company’s insolvency, these creditors are entitled to reclaim the assets and their fixed claim is recorded with Companies House.
Preferential creditors consist of employees who are owed outstanding wages and vacation pay. However, some employee payments in liquidation, such as notice pay and redundancy claims, are not considered preferential and instead fall under the category of unsecured creditors.
Secured creditors with a floating charge
The next in line for payment in an insolvent liquidation are creditors with floating charges over the company’s assets. Floating charges are claims on an asset class, such as stock, work in progress, or raw materials, and are recorded with Companies House by the lender. In the event of insolvency, the floating charge becomes a fixed charge.
A portion of the proceeds from assets available to floating charge holders is reserved for unsecured creditors, referred to as the “prescribed part.” This allocation is intended to increase the likelihood of unsecured creditors receiving some return, even if it is small.
Unsecured creditors consist of suppliers, customers, contractors, and clients of the insolvent company who must file a claim for repayment of their debt. As previously noted, it is common for this group of creditors to receive no payment from the liquidation process as they hold the lowest priority in the payment hierarchy.
Unsecured Creditors with a Personal Connection to the Company
Individuals with personal connections to the liquidated company, such as family members or friends, may also be owed money. However, they will only receive repayment after all other unsecured creditors have been fully paid.
Shareholders of the company are at the bottom of the priority list in a liquidation process and typically do not receive a return.
Note on HMRC’s Repayment Hierarchy
Starting from December 1st, 2020, HMRC will become a secondary preferential creditor for specific payments, such as PAYE, employee NI contributions, VAT, and Construction Industry Scheme (CIS) payments that the company holds on behalf of HMRC.
However, for taxes owed directly by the company, including corporation tax, HMRC will still be considered an unsecured creditor. This change in the creditor hierarchy for certain taxes means that unsecured creditors have a lower chance of receiving repayment from that date.
For further information on the creditor hierarchy in a liquidation process, InsolvencySupport.co.uk can provide assistance. You can contact one of their licensed insolvency practitioners for a free same-day consultation, as they have a widespread network of offices across the country.