Which creditors get paid first in a liquidation process?

Individuals and businesses owed money by a company are known as creditors. If the amounts they’re owed aren’t repaid and the company has to be liquidated, any unpaid debts remaining at the end of the process are written off.

As lack of cash is a fundamental element of insolvency, unfortunately this can mean that some creditors won’t receive any returns even when all the company’s assets have been realised.

In an insolvent liquidation, creditors are grouped into categories that determine their position in the payment ‘hierarchy.’ This is a statutory order of priority set out in the Insolvency Act, 1986, and the liquidator is obliged to make repayments in this order.

So what are the different categories of creditor, and which group is paid first in an insolvent liquidation process?

Creditor categories for repayment in liquidation

Initially, the fees of the liquidation process must be paid, and then there are three broad creditor groups:

• Secured creditors (divided into fixed charge holders and floating charge holders)
• Preferential creditors
• Unsecured creditors

Each group must be paid in full before the liquidator can start to repay the next.

Secured creditors with a fixed charge

These are generally banks and other asset based lenders that hold a fixed charge over the asset in question – vehicles, for example, property, or land. The lender is entitled to recover possession of the asset on the insolvency of the company, with the fixed charge being registered with Companies House.

Preferential creditors

Preferential creditors include employees with outstanding wages and holiday pay. Some employee payments in liquidation aren’t regarded as preferential, including notice pay and redundancy claims - claims for these payments are regarded as unsecured.

Secured creditors with a floating charge

Creditors holding a floating charge over company assets are next in line. Floating charges are held over an asset class, so could include stock, work in progress, and raw materials. Floating charges are also registered with Companies House by the lender - when a company enters insolvency the floating charge ‘crystallises’ to become a fixed charge.

A proportion of the proceeds of assets available for floating charge holders is also set aside for unsecured creditors. This is known as the ‘prescribed part’ and is intended to boost the chances of unsecured creditors receiving a return, however small.

Unsecured creditors

Unsecured creditors include suppliers, customers, contractors, and clients of the insolvent company, who must make a claim for repayment of their debt. As we’ve mentioned, it’s common for this group of creditors to receive no dividend at all from the liquidation process as they fall at the end of the payment hierarchy.

Unsecured creditors with a connection to the company

Sometimes family members, friends, and other individuals with a personal connection to the liquidated company are owed money by the business, but this group are only repaid when other unsecured creditors have been paid in full.

Shareholders

Company shareholders are placed at the bottom of the priority list in liquidation, and rarely receive a return.

A note about HMRC in the repayment hierarchy

For insolvencies that commence from 1st December 2020, HMRC will become a secondary preferential creditor for certain payments - outstanding taxes the company holds on behalf of HMRC such as PAYE, employee NI contributions, VAT, and Construction Industry Scheme (CIS) payments.

For other taxes owed directly by the company, including corporation tax, HMRC will continue to be classed as an unsecured creditor. This change in the hierarchy for certain taxes means unsecured creditors are even less likely to receive repayment from this date.

UK Liquidators can provide more information on the creditor hierarchy in a liquidation process. Please contact one of our licensed insolvency practitioners to find out more – we operate an extensive network of offices throughout the country and offer free same day consultations.