When all other avenues have been explored and the debt is overwhelming, a company may be left with little choice but to go into liquidation. This formal winding-up process is technically known as a Creditors' Voluntary Liquidation (CVL) and sees a very fixed liquidation order of priority dictated by the 1986 Insolvency Act.
The liquidation order of priority
When a company is formally wound up, all the funds, assets and income is collected, and a plan is put in place to pay off creditors. Each creditor must be paid in full before moving on to the next - and working out who gets paid in what order and how much they receive is one of the main tasks of the insolvency practitioner.
Some company owners and directors assume there is a level of flexibility around who is paid what and in what order and can often be quite surprised to find out that this is really not the case at all - in fact, there is a very strict formula and set of guidelines which must be adhered to.
The hierarchy of creditors
A preferential creditor is a creditor who is granted preferential status by receiving the right to first payment. Once the preferential creditors are paid in full, funds will then be allocated to the next in the following order: secured creditors with a fixed charge, preferential creditors, secured creditors with a floating charge, unsecured creditors, connected unsecured creditors and then shareholders:
1. Secured creditors
At the top of the creditor hierarchy are large, fixed asset-secured loans with major financial institutions such as banks. Basically, if a bank lent the business funds and the loan was secured against a property or land, they’re the first to be paid back in full wherever possible. Assets typically covered by a fixed charge include property, machinery, and vehicles. A good example of this is a car that is bought on finance; if the owner wants to sell the vehicle, the finance company needs to be paid off in order to do so.
2. Preferential creditors
After the banks, the next in line for a pay-out are what’s known in the industry as preferential creditors. This basically means any employees or former employees that are owed wages, bonuses or unpaid holiday. Former employees owed redundancy pay-outs or wages in lieu of notice are not entitled to this preferential status.
As of 1st December 2020, certain debts owing to HMRC are to be included in a category of secondary preferential debts. The debts granted secondary preferential status are VAT, PAYE, employee National Insurance contributions, deductions on account of tax from contract payments and student loan repayments. However, HMRC remains an unsecured non-preferential creditor for all other tax debts.
3. Secured creditors with a floating charge
A floating charge is the opposite of a fixed charge and is the amount owed liable to change during the course of the loan. However, when a firm goes into liquidation, that floating charge ‘crystallises’ and becomes fixed. Secured creditors with such charges are next in line, however an amount of these monies is often set aside for unsecured creditors – which is referred to as the ‘prescribed part’.
4. Unsecured creditors
Next up are unsecured creditors who are owed funds such as the company’s suppliers, or even customers if contracts are broken causing losses. There can be huge sums owed to those waiting patiently on this rung of the repayment ladder, including contractors and landlords - and there may even be claims for interest on these debts to be assigned if the pot allows for it.
HMRC also remains an unsecured non-preferential creditor for certain tax debts, such as corporation tax and employer National Insurance contributions.
The last people on the list to receive money when a company goes into liquidation are the shareholders. On the face of it, it may appear bizarre that people who faithfully invested their own money in the firm are the last to see any back. However, investing is inherently risky and the chance of the business failing will have been weighed up by the shareholders before they signed over their funds initially.
As such, shareholders only see money from the liquidation process if the insolvency practitioner is fully satisfied that all other creditors above them in the pecking order have had their debts fully settled.
How McAlister & Co can help
When it comes to administration, liquidation and the sale of company assets, the liquidation order of priority can be a complex subject. What’s more, if a business enters insolvency, it’s important to maximise the interest of the creditors in order to avoid accusations of wrongful or unlawful trading, which could lead to 15 years of disqualification.
If your business is failing and you’re concerned that your creditors may not be sufficiently remunerated, you need to instruct a trusted and respected insolvency practitioner. At McAlister & Co, we will quickly and accurately assess your situation, give the necessary advice, and take the necessary action.
In addition, we will also strive to raise as much money as humanly possible for all assets before setting about paying back your creditors and settling matters as fairly as we can. For more information on how we can help, please contact us today.
You don’t have to face financial difficulty alone - our friendly, dedicated team will be more than happy to help. Alternatively, why not download our guidance notes for directors for more help and advice.