In business a preferential creditor refers to a creditor who has the right to payment before others in the event of the company, partnership, LLP or sole trader’s insolvency.
Insolvency events include, liquidation, administration and CVAs and bankruptcy for sole traders.
The concept is known as the ranking of creditors in insolvency. 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 ranking is as follows;
- Fixed charge creditors come first; these are creditors who may have a charge over property. For example a mortgage lender or factoring provider, or an invoice finance provider for example.
- Primary preferential creditors – these are the unpaid employees of the failed company or business.
- Secondary preferential creditors – these are HMRC for PAYE deductions, national insurance deductions, VAT and CIS.
- Prescribed part creditors – these are unsecured creditors – for more information see this page
- Floating charge creditors these are lenders, banks and other holding a debenture as security. See this page for detailed analysis of fixed and floating charges
- Unsecured creditors – such as suppliers, trade creditors, landlords and corporation tax.
What happens to the money paid out by insolvency practitioners in liquidation, administration and CVA?
The ranking above sets out how the money is legally distributed, if there is any to distribute!
These are complex rules and you should speak to us about this order of priority if you have any questions.
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) are paid out first. Pension scheme contributions and holiday pay are entitled to be paid.
If employees are owed more than £800 then 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/salaries have been paid. If in this case an employee is owed £2500 for salary how would they recover this?
The employee would receive £800 from the liquidator or more likely the Redundancy Payments Office part of the Insolvency Service (RPO) and the balance of £1700 would become an ordinary unsecured debt. This is unlikely to be recovered by the employee.
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 £643 per eligible week.
Secondary Preferential Creditors
HMRC Debts Pre-2002 HMRC was classed as a preferential creditor. In 2002, the new revisions of the Enterprise Act meant this right was removed, making them an unsecured creditor from 2003 until 2020.
However as of 1st December 2020, HMRC rank ahead of floating charge holders in any insolvency. This may mean that lenders get less recovery in insolvency 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.
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.