KSA Group has created an infographic to explain in simple terms the order of priority for paying creditors if you’re a company that’s going through insolvency.
For further information, please refer to the flowcharts below:
At the top are secured, creditors. Secured creditors have a legal right or charge over the property. Now, the 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.
Fixed and floating charges:
Usually, the fixed and floating charge is given under a debenture and this must be considered carefully. Before any signature or completion, it is essential to take expert and independent legal advice before signing. However, we would assume that if the reader is looking at this page that a debenture already exists.
Fixed charge creditors:
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 (there must be a consideration for fixed and floating charges) has relinquished permission to trade or sell the property in question without the explicit permission of the charge holders. Usually, a fixed charge exists over, for example, a piece of machinery. Because this machinery is used to develop the economic activity of the business in question it is unusual or abnormal for the business to want to set sell or trade this piece of equipment. If the machinery in question was redundant or no longer sufficiently efficient than the company may seek to sell this equipment but would have to seek permission from the fixed charge holder first. Usually, this is not withheld as the proceeds for the sale would probably be used to pay down borrowings.
Floating charge creditors:
An altogether more complicated situation exists under the floating charge. 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. This can be complicated to apply, for example, a fixed charge may exist on a piece of machinery which is sold in liquidation the proceeds of which would go to the fixed charge holder. If the machinery was sold for say 10,000 more than the fixed charge then this amount is covered under the floating charge collection. Under any floating charge created before 15th September 2003any floating charge collections are payable to preferential creditors first. Under any new floating charges created from September 15th, 2003 all collections are the first subject to a prescribed PART which must be set aside for the unsecured creditors. This is calculated as follows 50% of the first realization up to £10k and 20% of £10k to £600k is paid to unsecured creditors with the balance going to the floating charge.
This is a very complex area and advice should be taken a soon as possible if you do not understand the position. We have produced a new page on fixed and floating charges that will help to explain them.
Please feel free to call us on 0800 9700539 or use our contact form on our website.
From 15th September 2003, the Inland Revenue and VAT’s preferential status was abolished under the Enterprise Act 2002. This will lead to a lower dividend than the Crown creditors use to enjoy BUT a higher dividend in insolvency should be received by trade creditors (for example) than previously. 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 deductions for employees through a PAYE Scheme and for VAT, trade creditors, suppliers, unsecured portion of fixed charge debts, national non-domestic rates, and some employees’ claims for example.
Connected unsecured creditors:
Usually, this is where a director or employee has provided money to the company on an unsecured basis, non-payment of salaries and wages or 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. Associate or connected creditors can include family members of staff or director’s spouses etc. 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 the 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.
are, of course, many different classes of shareholders and there are many complex issues appertaining equity – it is not the purpose of this guide to go into these areas but should the reader require advice they are encouraged to discuss this matter with their professional advisors. It is quite common for shareholders to covert some of the equity into secured debt to ensure that they are paid in the event of a collapse.
Above all the reader should remember this key point.
If the company is insolvent (see our guide by clicking the word insolvency) then the directors have a duty of care to act to maximize the body of creditor’s interests. This means acting in the best interests of all creditors, by assessing the situation, collating as much information as possible, looking at their objectives, studying the options available and making a decision to ACT.