There are two ways an insolvent company can be liquidated – either voluntarily by the directors instructing an Insolvency Practitioner to convene meetings of shareholders and deciding on a creditors’ decision; or compulsorily, usually by a creditor petitioning at court for the winding up of the company.
When a company is liquidated it may be the case that sufficient funds are generated from its assets during the liquidation to cover the costs of the liquidation and for payment to made in full to all creditors, regardless of the kind of debt they are owed.
However, if the funds generated from a company’s assets are insufficient to repay all of the liquidation costs and creditors, a repayment hierarchy determines the order in which the costs of the liquidation and creditors are paid.
It is important for creditors to understand where they sit in this hierarchy, as this determines how likely it is that they receive funds from a liquidation.
What is the order of payment in liquidation?
The order can be summarised as:
- Secured creditors with a fixed charge
- Fees and expenses of the Liquidator
- Preferential creditors
- Secured creditors with a floating charge
- Unsecured creditors
- Shareholders
Secured creditors with a fixed charge (Fixed charge holders)
Fixed charge holders are lenders, often banks, who hold ‘fixed’ security over an asset or assets of a company. This prevents the company, or its liquidator, from selling or trading the assets in question, without permission from the lender.
It also means that the proceeds of sale of these assets, less reasonable costs of sale, are payable to the fixed charge holder. An example of a fixed charge would be a mortgage over a property.
If assets subject to a fixed charge are sold for enough money to pay the fixed charge holder in full, then the surplus funds then flow down through the hierarchy as set out below.
Not all companies grant fixed charges, which means all funds generated from company assets are also applied as set out below.
Fees and expenses of the Liquidator
The fees of the liquidator are agreed by the creditors and are payable from funds generated from the company’s assets.
Other liquidation expenses are also payable in a liquidation and these may include for example insurance costs, legal fees and agent’s fees related to asset sales. These expenses sometimes need to be agreed by creditors and sometimes do not.
As explained above, where the liquidator’s fees and expenses relate to their work dealing with assets subject to a fixed charge, these costs are paid from funds generated from the assets subject to the fixed charge only.
All other fees and expenses, for dealing with any other assets and for dealing with all other aspects of the liquidation, are payable from funds generated from other company assets and are payable ahead of creditors.
Preferential creditors
Preferential creditors have no security over company assets. However preferential creditors are given preferential status in law i.e. the law says that after fixed charge holders and the liquidator’s fees and expenses, they are at the front of the queue for payment.
These creditors are typically the employees of the company who are owed arrears of wages or holiday pay, although not pay in lieu of notice or redundancy payments, which are non-preferential and are further down the hierarchy.
Preferential creditors may also include HMRC. All VAT owed by a company has preferential status and so does a proportion of any PAYE debt. If a company owes a lot of VAT or PAYE and its assets do not generate enough to pay these debts in full, this will unfortunately mean that no other creditors receive payment from a liquidation.
Secured creditors with a floating charge (Floating charge holders)
Once preferential creditors have been paid, next come any creditors who hold a ‘floating charge’ over company assets.
Any creditor can hold a floating charge, although these tend to be held by banks. To have a floating charge, the company in question needs to have signed an agreement giving the lender a floating charge and this agreement is known as a debenture. Some companies do not ever sign a debenture and in this case there will be no floating charge holder and any available funds will flow further down the hierarchy of payment.
If a company has signed a debenture, this will normally grant a charge (security) over all the remaining assets of a company (i.e. all assets not subject to a fixed charge). However a floating charge differs from a fixed charge, because the law says that fixed charges can only apply to certain company assets.
Some company assets, for example stock, need to be bought and sold by a company without having to ask a charge holder for permission, otherwise the company would not be able to trade effectively. Assets subject to a floating charge often vary day to day or change over time.
Other examples of assets that can be subject to a floating charge (but in general not a fixed charge), include cash in company bank accounts and book debts (funds due to the company from customers and other parties).
The funds generated from these assets by the liquidator (once the liquidator’s fees and expenses and any preferential debts have been paid), are payable to the floating charge holder.
The law does say however, that a small proportion of the funds available to the floating charge holder must be put to one side to pay other company debts, which would otherwise be lower down the hierarchy of creditors. This is a called the ‘prescribed part’ and is worked out by the liquidator.
Unsecured creditors
If the funds generated from the company’s assets have been sufficient to pay any fixed charge holders, the liquidator’s fees and expenses, any preferential creditors and any floating charge holders in full, then there will be money left over for the remaining creditors, who are known as ‘unsecured creditors’.
This includes all remaining creditors such as suppliers, contractors, landlords, customers, corporation tax, the balance of any PAYE debt and any director’s loan account.
Any remaining funds are paid equally to all these creditors, on a “pari passu” basis, which means all creditors receive the same percentage of what they are owed. These creditors also received the ‘prescribed part’ referred to above.
Shareholders
Shareholders will only receive a payment from a liquidation if all the liquidator’s fees and expenses and all creditors have been paid in full (plus statutory interest on their debts). If a company has enough money to pay its debts in full, then it should not enter insolvent liquidation.
Personal guarantees
Directors or other parties can be asked by creditors to sign personal guarantees as part of the agreement for funds to be loaned to a company. This tends to happen more often with smaller and newer companies seeking to obtain bank financing or property leases.
The creditor should claim against the company first, but creditors can also pursue the personal guarantee as well. If the creditors are repaid under the guarantee, then the guarantor (the person who gave the guarantee) can submit a claim in the liquidation and may be able to take the place of the company creditor they have personally repaid. This can lead to a guarantor receiving funds from the liquidation.
Summary
A Liquidator must try to generate as much money as possible from a company’s assets and their fees are also subject to approval by creditors.
Whilst this means the chances of creditors receiving a return are increased, often the prospects of them receiving payment will depend on the kind of debt they are owed and where they sit in the above hierarchy of payment.
If you need advice on where you stand as a creditor in a liquidation, or if you believe your company might be insolvent, Bridgewood would be pleased to assist.
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