What is the order of priority for Creditors in relation to Corporate Insolvency?

Insolvency

Sometimes a company gets into a serious financial trouble. It is the responsibility of the director to spot this problem and try to resolve it. If a company is in financial problems it has several options how to sort this out. A company should start one of its insolvency procedures. A company can therefore agree either formally or informally with its creditors on the extension in funding on some terms, it can put itself in administration, call in a receiver or put itself into liquidation. There are various collective and enforcement insolvency procedures which help resolve the matters. The difference between the two procedures is that enforcement procedure enables the creditor to enforce its rights against the company as opposed to collective procedure. Primary aim of collective procedure is to help the company survive.

Administration

Administration is one of the insolvency procedures whereby its aim is to rescue the company. Creditors will be unable to enforce their rights against the company without the court consent. An administrator must be appointed. The administrator will then manage the company with a view to succeed and rescue it. The appointment will put a stop on all creditors’ actions without court consent, such a stop is called moratorium. E.g. no order to wind up a company can be made, no administrative receiver can be appointed, and the landlord will not be able to forfeit the property.

Receivership

There can be a few different types of receivers. The appointment of an administrative receiver represents a type of an enforcement procedure whereby the creditor will want to get paid by realising the assets over which he holds the security. Administrative receiver will take possession of the assets, sell the assets of a company and repay the debenture holder. There is a significant disadvantage in calling in an administrative receiver. There is no moratorium while there is administrative receivership. This effectively means that creditors may still apply for winding up order.

Liquidation or winding up

Liquidation is a procedure whereby the company’s assets are realised and divided between all of its creditors. Liquidation can be voluntary or compulsory. Following the liquidation the company will cease to exist. There must be sufficient grounds for the company to be wound up. The most common grounds can be for instance: if the company is unable to pay its debts and if the court thinks that it will be just and equitable to wind up that company. The order of priority is set out in the Insolvency Act 1986. The liquidator will divide the proceeds of the sale of assets between creditors. The liquidator must also try to maximise the amount of assets which could be sold so that the highest amount of creditors get paid.

The Order of Priority on winding up of a company

Why is there a need for such an order?

Upon winding up of a company, the company in other words goes into liquidation. Its assets and capital will fall apart and there is a need to sort out who gets the proceeds of the company’s assets or the remaining capital. A company may have some employees who will be expected to get paid regardless whether the company goes into liquidation or not, there may also be some creditors for instance a bank which will expect to be repaid for the loan that it lent to the company, there may be some shareholders who bought some shares of the company and they now expect to be paid dividends. All these are a part of a business and therefore there is a need for an order of priority to be clear in relation to who gets the priority first.

The order of priority differs depending on whether administrative receiver was appointed or not. If administrative receiver was not appointed the order is as follows. The first ones to be paid are liquidator’s costs.

Liquidator’s costs

These are the costs for e.g. realising fixed charged assets.

The next one to get paid are fixed charge creditors. They are creditors to whom the company owes some money but they hold security over some company’s assets. This security is called fixed charge and therefore they may be entitled to sell it or get the proceeds of sale as in accordance with the agreement. The next ones to be paid upon winding up are those who paid other costs and expenses of liquidation. Preferential creditors follow after these.

Preferential creditors

Preferential creditors are those to whom the company owes some money and it is a preference to return them the same. These can include for instance employees who were not paid their salaries. There is however a limit on money per an employee.

Ring fenced fund follows after preferential creditors.

What is ring fenced fund?

Any realisation of a floating charge which would be normally available to the holders of floating charge is set aside and this will be available to company’s unsecured creditors.

Floating charge creditors are the next one to be paid on a winding up of a company. Floating charge is a charge over an asset of the company which becomes a fixed charge. Unsecured creditors come after floating charge creditors. Unsecured creditors are for instance crown debts or other remuneration to employees. The company will also be still liable to pay the interest accrued on debt which comes after unsecured creditors in a priority order. The shareholders are the last ones to get paid.