What Is a Preferential Creditor?

A preferential (or preferred) creditor refers to a creditor who has the right to payment before others. The priority of secured, preferential, and unsecured creditors is set out in the Insolvency Act 1986 and updated by various changes to insolvency legislation since then. The concept is known as the ranking of creditors in insolvency.

The Full Creditor Ranking

The ranking of who gets paid first is as follows:

1. Fixed charge creditors come first; these are creditors who may have a charge over property, for example a mortgage lender or factoring provider.
2. Primary preferential creditors – these are the unpaid employees of the failed company or business.
3. Secondary preferential creditors – these are HMRC for PAYE deductions, national insurance deductions, VAT and CIS.
4. Prescribed part creditors – these are unsecured creditors.
5. Floating charge creditors these are lenders, banks and others holding a debenture as security.
6. Unsecured creditors – such as suppliers, trade creditors, landlords and corporation tax.

These are complex rules and you should speak to us about this order of priority if you have any questions.

The Details of Preferential Creditors

Primary Preferential Creditors: Company Employees

Employees of the company are given higher priority as these people put their time and effort into the company. Any unpaid wages (up to a maximum of £800), pension scheme contributions and holiday pay are entitled to be paid. Employees have had and will continue to have, long-standing title as preferential creditors.

If employees are owed more than £800, the remainder of their debt is classed as unsecured debt. For example, if a company goes into liquidation on the 25th of a month and no wages have been paid, and an employee is owed £2,500 for salary, they would receive £800 from the liquidator (or the Redundancy Payments Office) and the balance of £1,700 would become an ordinary unsecured debt, which is unlikely to be recovered.

Remember, redundancy claims and lieu of notice claims are NOT primary preferential creditor claims. These are usually met by the RPO but are capped at £719 per eligible week.

Secondary Preferential Creditors: HMRC

As of 1st December 2020, HMRC ranks ahead of floating charge holders in any insolvency. This may mean that lenders get less recovery due to lower recovery under a floating charge. HMRC ranks as a secondary preferential creditor in relation to any taxes paid by employees and customers that are held by a business on their behalf, i.e. PAYE, VAT, NICs and Construction Industry Scheme deductions. For corporation tax and any other taxes owed directly by a company, HMRC is an unsecured creditor. There is no age limit on secondary preferential creditors.

What Happens to the Money?

The ranking above sets out how the money is legally distributed, if there is any to distribute! When speaking to insolvency advisors such as ourselves it is always good practice to have prepared a list of the debts owed to HMRC and to banks/lenders with security. Please also have a list of all unsecured creditors available as that helps us advise your company.