When a company can no longer pay its debts and enters into an insolvent liquidation, there’s a set order in which creditors are paid out. That order is set out in the Insolvency Act 1986, which determines which group of creditors is paid first.
The priority of payment during an insolvent liquidation can be summarised simply as follows:
- Secured creditors with a fixed charge
- Liquidator’s costs and fees
- Preferential creditors
- Secondary preferential creditors
- Secured creditors with a floating charge
- Unsecured creditors
- Shareholders
Fixed charge holders are often banks and other lenders who have a charge over a business asset that is used long term in the business, typically property or machinery. Preferential creditors include employees entitled to arrears of wages and holiday pay, while secondary preferential creditors are certain HMRC debts like VAT and PAYE taxes.
Assets subject to a floating charge include stock and raw materials, realisations for which are often severely compromised in a liquidation. Unsecured creditors include trade creditors, suppliers, customers, contractors, rent arrears, unsecured loans, overdrafts, and more. The fact they sit a long way down the order of priority at level 6 means that in most cases they receive nothing or only a very small percentage of the debt owed to them.
There is however a ‘divergence’ from the above table where there is a floating charge which was taken out after 15 September 2003…
The introduction of the ‘prescribed part’ in 2003 was intended to provide some – albeit normally small – measure of protection to unsecured creditors. The prescribed part is an amount set aside from floating charge realisations which is paid out to the unsecured creditors rather than to the floating charge holder. Fifty percent of the first £10,000 realised from the sale of floating charge assets and 20% of any further realisations (up to £600,000) is paid to the unsecured creditors as the prescribed part.
While this measure does provide some protection to unsecured creditors, the reality is that they are still at a massive disadvantage in an insolvency situation, being so very low down in the order of priority.