When a company goes into Liquidation, one of the challenges facing the Insolvency Practitioners (IPs) dealing with the case, is explaining to stakeholders where they fit in the pecking order for payments out of the funds generated in the case. For insolvency specialists, the process is logical and straightforward; for most other interested parties it is anything but.
Key points for stakeholders
- Secured creditors with a fixed charge are paid from the proceeds of realising those assets to which their charge applies, ahead of the other stakeholders.
- Directors’ loans and connected party claims are treated as unsecured creditors, unless they are secured by a valid charge over the Company’s assets.
- Directors can become liable for some or all of their Company’s debts if Wrongful Trading or Fraudulent Trading is proven, and also in some circumstances by HMRC when they have a history of leaving tax liabilities unpaid.
The payment priority waterfall
A simple way of understanding how Liquidation proceeds are allocated between stakeholders is thinking of the process like a waterfall, with money cascading down into and through a succession of recovery rock pools, where the lucky ones can scoop out enough to repay their debts before any remaining monies flow down into the next pool.
The stakeholder queue
Where do the various stakeholders stand?
Secured creditors with a fixed charge
These are normally banks or other lenders, who protect themselves against a default by taking what is usually called a debenture over all the assets including a fixed charge over specific assets, such as property, intellectual property, goodwill or in some instances, trade receivables. They have first call on the net proceeds after costs of realising these assets, but any surplus goes into the general Liquidation ‘pot’.
The reason for putting them first in the priority list is this is what was agreed with the borrower and in reality, they would lend less or not lend at all without this priority. This would be bad news for individual borrowers and for the economy in general. Ongoing interest charges and fees due under the borrowing agreement continue to accrue and will increase the debt until it is repaid.
Liquidation costs
The IPs appointed as Liquidators to a Company’s are independent professionals, who were not part of the management team under whose control the Company’s problems happened. As such, they are entitled to be paid for the work they do and be able to recover the costs they incur in carrying out their duties under the insolvency legislation. Nevertheless, their fees and the Liquidation costs are subject to scrutiny, control and approval by the creditors and when necessary, by the Court. They routinely write off a significant percentage of their costs for acting as Liquidators.
Preferential creditors
Once the Liquidation costs have been paid, next in line are the preferential creditors, who will be employees for arrears of pay and outstanding holiday pay up to certain statutory limits. Putting these claims at the top of the payments priority list is a clearly in the interests of public policy and fairness.
This is different to the protection of employee claims through the Redundancy Payments Service, which underwrites some employee claims within certain statutory limits if there are insufficient funds in the Liquidation to meet them.
There are other potential preferential claims, including protective awards by an Employment Tribunal, claims under the Financial Services Compensation Scheme or for environmental damage.
Secondary preferential creditors
HMRC were moved up the order of priority from unsecured creditors to secondary preferential status in December 2020. Only certain specified HMRC debts qualify:
- Value Added Tax (VAT)
- Pay As You Earn (PAYE) Income Tax
- Employee National Insurance contributions (NICs)
- Student loan repayments collected through a payroll scheme
- Construction Industry Scheme deductions
The ‘prescribed part’ for unsecured creditors
It is in the public interest that unsecured creditors should not lose out completely in any Liquidation where there are funds left over after the preferential and secondary preferential creditors have been paid, but not once floating charge (see below) claims have been satisfied. This is done by carving out of the residual funds a nominal amount calculated by reference to the asset realisations but limited to a maximum of £800k (or £600k for floating charges created before April 2020).
Secured creditors with a floating charge
When a lender takes security over a Company, it looks for extra protection from a ‘floating charge’ over those types of assets where it cannot take a fixed charge, because they constantly change. Inventory is an example. If the lender’s debt is not fully repaid out of the proceeds of fixed charge assets, it can then recover further funds from the floating charge asset realisations.
Unsecured creditors
This category covers suppliers, service providers and landlords, or their trade insurers. They trade with customers without any protection and at maximum risk, which places them almost at the bottom of the payout queue. This is why amounts owed to Directors or connected parties for loans qualify as unsecured creditors. By definition they know more about and can control the risk they are taking and are expected to accept unsecured status as a consequence if their Company’s fails.
Shareholders
Those providing equity to a Company are at the bottom of the pile when it comes to the distribution of funds in a Liquidation. This too is public policy, recognising that unlike almost all other stakeholders, the shareholders stand to receive the upside of a Company’s success by way of a capital gain on their investment.
Get advice and get it early
Any stakeholder worried about their recovery prospects in a Liquidation or needs advice on how to protect their position in the run up to a potential insolvency should take independent expert advice at the earliest possible moment.
At Opus, we have extensive experience assisting business owners and directors with concerns and challenges. We will always work with you to find the best solution for the business. If you would like to speak to Opus, one of our Partners would be more than happy to have a non-obligatory, confidential chat with you. We can be contacted at rescue@opusllp.com or call us on 0203 995 6380 and we will arrange for a call with one of our specialists.