When dealing with creditors in insolvency situations, it is vital to remember the order of priority. Who ranks above whom? Where does the bank and HMRC rank? If the bank has security, do employees rank ahead of them? These are all common questions we get asked.
The simplest way to answer these questions is to imagine creditor ranking as a ladder. Here we explain both pictorially and in written format.
Secured creditors are paid first over any other creditor. Secured creditors have a legal right or charge over property. Property can mean anything from bricks and mortar to plant and equipment, motor vehicles, fixtures and fittings, particular pieces of machinery or things such as patents or intellectual property. This charge is called a debenture and is taken out at the time of the loan.
The fixed and floating charge is usually given under a debenture and this must be considered carefully.
The easiest way to understand a fixed charge creditor’s rights is to think of their position as holding title to or ownership of the property in question. Whilst this isn’t strictly legally correct, it is a simple way to understand their position. This means that the person (company) who has given the fixed charge to a bank or other lender has relinquished permission to trade or sell the property in question, without the explicit permission of the charge holders.
Essentially the way to remember how floating charge works is as follows: all items that the company uses, or sells or trades in the normal course of business where it isn’t possible to refer to a fixed charge holder for permission are covered by floating charges.
Under any floating charge created before 15th September 2003, any floating charge collections are payable to preferential creditors first. Under any new floating charges created from September 15th 2003, all collections are first subject to a prescribed PART which must be set aside for the unsecured creditors.
HMRC is what is called secondary preferential creditors. VAT and PAYE are classed as such but other taxes on the company like corporation tax are not.
Employees retain the status of preferential creditors for their arrears of pay and for holiday pay claims in insolvency situations.
Unsecured creditors now include HMRC for some monies like corporation tax but not for deductions for employees through a PAYE Scheme and for VAT as that is now preferential. Trade creditors, suppliers, unsecured portion of fixed charge debts, national non-domestic rates and some employees’ claims can also be included.
Usually this is where a director or employee has provided money to the company on an unsecured basis, non-payment of expenses can fall into this area. The technical term is “associate creditors” this means that the creditor is in some way associated with the company. Connected creditors will not generally receive a dividend in a CVA but would be eligible for a dividend in liquidation. Usually, however, the dividend for unsecured / connected creditors is nil in liquidation.
Unfortunately, at the bottom of the pile comes members, otherwise known as shareholders. Shareholders are people (or companies) who have provided money to the business on a risk basis and are therefore not entitled to remuneration, dividend or repayment of their exposure until all of the above creditors are satisfied. Hence the name risk capital! Shareholders are at the biggest risk of losing their money.
If the company is insolvent then the directors have a duty of care to act to maximise the body of creditor’s interests. The message is clear: if the business is insolvent think very carefully about payment to creditors. If after reading this page you are unsure what the order of priority should be, please call our technical support team on 0800 9700539.
Written ByRobert Moore
Marketing Manager
Rob has over a decade of experience in web and general marketing. He has extensive knowledge of the Insolvency sector and has helped many worried directors with their questions.
Rob is now working with the Board at RMT KSA to develop strategic marketing programmes to support the business plan and drive more company rescues.
