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Undoubtedly, you’ve found yourself searching for answers to the question, “When a company goes into liquidation, who gets paid first?” Fortunately, you’ve come across this unique resource. When a business enters into a formal insolvency procedure such as Liquidation or Administration, it means it is unable to meet its financial obligations as they fall due.
Creditors are the individuals or entities to whom the company owes money. When a company goes through liquidation or Administration, you might wonder who receives payment first. In this article, we will delve into the order in which creditors are paid if the company becomes insolvent and its assets are sold to repay outstanding debts during a liquidation or Administration process.
Understanding Company Administration
An Administration is designed to hold a business together while plans are formed either to put in place a financial restructuring plan to rescue the company, or to sell the business and assets to produce a better result for creditors than a liquidation. Administration can also be used where neither of these objectives can be achieved, simply as a mechanism to liquidate assets and distribute the proceeds to secured or preferential creditors, but this is not the primary purpose of the law.
Once an Administrator is appointed, he takes over the running of the company from the directors and is responsible for any decision to continue or discontinue trading and he has control over how the company and/or its assets are disposed of. The ability to continue trading depends on the availability of funds for working capital, the willingness of existing suppliers and customers to deal with the company in Administration and other factors specific to the company’s business, such as licensing rules.
Understanding Company Liquidation
Creditors’ Voluntary Liquidation (CVL) is the process where the directors of an insolvent company can voluntarily take steps to wind up the company. The directors convene a meeting of the company’s shareholders to consider resolutions to wind up the company and appoint a Liquidator, and to seek a decision from the creditors on the appointment of a Liquidator.
Once appointed, the Liquidator takes control of the company from the directors and although a short period of trading may take place to complete outstanding contracts, it is more common for the company to cease trading and its assets sold to repay the costs of the Liquidation with any surplus being paid to creditors in the priority set out in the legislation.
Prioritising payments when a company goes into Administration or Liquidation
The Insolvency Act 1986 establishes a legal hierarchy that determines the order in which creditors are paid during a company Liquidation or Administration, it must settle the outstanding debts of each group of creditors in full, except for secured creditors with a “prescribed part,” before moving on to the next set. The creditor categories are as follows:
- Secured Creditors with a Fixed Charge – Secured creditors with a fixed charge are typically the first to be compensated during insolvency. They hold a legal interest or charge over specific assets or all of a company’s assets. These assets can include equipment, properties and intellectual property such as goodwill. Secured creditors may include leasing companies and banks. Often, a bank will only lend money if the borrower signs a document assigning security for the debt. Fixed charges significantly reduce the bank’s risk since it allows them to assume ownership of the asset in the event of insolvency.
- Preferential Creditors – Next in line are employees, who are considered ordinary preferential creditors for unpaid salaries up to £800 and holiday pay claims. Then it is secondary preferential creditors are paid, according to the Finance Act 2020, which include HM Revenue and Customs (HMRC) for any outstanding VAT or PAYE.
- Secured Creditors with a Floating Charge – Floating charges are typically granted over non-fixed assets such as raw materials or work-in-progress. The holder of a floating charge registers it at Companies House, and when an insolvency event occurs, this floating charge crystallises and becomes fixed. A portion of the assets reserved for floating charge holders, known as “the prescribed part,” is allocated to unsecured creditors. This reserved amount is the surplus remaining after selling the assets subject to the floating charge and this amount is then used to provide unsecured creditors with an opportunity to recover a portion of their outstanding debts.
- Unsecured Creditors – This group encompasses contractors, customers, trade creditors, suppliers, and individuals or organisations with claims. Essentially, unsecured creditors are those who provide funds without receiving specific assets as collateral. It also includes managers or staff members who have unofficially loaned money to the company (known as associate creditors).
- Shareholders – Lastly, the shareholders of the insolvent company rank at the bottom of the list for repayment. Shareholders are individuals who have invested money in the company and, therefore, are not eligible for settlements or reimbursement in a business Administration or Liquidation unless all the above-mentioned creditor groups have been paid.
Seeking Assistance for Company Debt Concerns
Each group of creditors must be fully reimbursed (with the exception of the floating charge creditors) before the Liquidator can distribute funds to the next set. It is crucial to prioritise the interests of creditors once your company becomes insolvent to avoid accusations of illicit or unauthorised trading. Understanding fixed and floating charges can be complex, especially when multiple charges exist on an asset. At Umbrella.UK Insolvency, our experts can provide clarity on your company’s financial position and identify the order of payment priority. Furthermore, we will ensure that you fulfil your rightful responsibilities as the leader of an insolvent company and help mitigate the risk of allegations.