What is the order of priority for creditors in a corporate insolvency?

Insolvency

If a company gets into a serious financial trouble and is unable to pay its debts as they fall due, or if the value of a company’s assets are less than the value of its liabilities, the company is insolvent. If this situation arises, the company has several options open to it, including:

  • company voluntary arrangement;
  • administration;
  • liquidation.

Company voluntary arrangement

A company voluntary arrangement (CVA) is where a company comes to a binding agreement with its creditors to decrease or rearrange its debt arrangement while the company restructures its business model. A CVA usually allows a company to continue trading to try and raise the money to repay its debts and can be started by either the company’s directors or by an administrator/liquidator if one has already been appointed. The process is overseen by an insolvency practitioner who will review the company’s financial situation and approve plans to repay the company’s debts.

Administration

Administration is an insolvency procedure which aims to rescue the company in the interests of the creditors. Creditors will be unable to enforce their rights against the company without court consent. An administrator must be appointed who takes over the management of the company with a view to helping it out of its financial problems and rescue it. They will come up with a restructuring proposal which must be approved by the creditors. If the administrator is unable to save the company, they can wind up the company and distribute the assets.

Liquidation

Liquidation is a procedure whereby the company’s assets are realised and divided between all of its creditors. A liquidator is appointed who must try to maximise the amount of assets which could be sold so that the highest amount of creditors get paid. 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 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 on winding up of a company

Upon the winding up of a company, there is a need to sort out who gets the proceeds of the company’s assets or the remaining capital. A company may have employees who will expect to get paid; there may be creditors – for instance a bank – which will want to be repaid for the loan it made to the company; there may be shareholders who bought shares in the company and now expect to be paid dividends. All of these are a part of a business and therefore there is a need for an order of priority to clarify who gets what first.

The liquidator will divide the proceeds of the sale of assets between creditors. The order of priority is set out in the Insolvency Act 1986. These are:

  • fees and expenses relating to the administration or liquidation;
  • fees of the insolvency practitioner/liquidator;
  • fixed charge secured creditors – these include lenders, such as banks, to whom the company granted title over a business asset in return for the loan;
  • preferential creditors and ‘prescribed part creditors’ – preferential creditors include employee claims (although there is a maximum amount set by the Government which can be paid to each employee), while the ‘prescribed part’ is an amount which is set aside from the sale of floating assets by the liquidator for the benefit of unsecured creditors;
  • secured creditors with a floating charge – assets subject to a floating charge can include any company property not subject to a fixed charge. The terms and conditions of the floating charge must have been outlined in a document called a debenture, signed by the company directors and registered by the lender at Companies House’
  • unsecured creditors – this includes HMRC, customers, contractors and suppliers;
  • shareholders.