Who gets paid what in a formal insolvency procedure?
The Insolvency Act 1986 and related Rules set out the order of priority in a formal insolvency.
Each class of creditors is paid in full before funds are allocated to the next category which helps to explain why unsecured creditors often fare badly in liquidation procedures. Creditors are ranked as follows:
- IP fees and expenses
- Secured creditors
- Preferential creditors
- A creditor holding a floating charge (subject to the Prescribed Part)
- Unsecured creditors
- Connected unsecured creditors
IP fees and expenses
The IP’s fees for administering the process are first to be paid. Administrative costs and expenses can be incurred when holding meetings, realising assets, engaging other professional advisers, distributing funds, providing accounts and reports, and investigating the conduct of directors.
The most common type of secured creditor is a bank but other asset-based lenders e.g. an HP provider, may well own assets used by a company. In such cases, the company has no right to sell or trade the item. Sales of heritable property, plant, vehicles, etc. tend to occur only with agreement between the secured creditor and the IP.
Preferential creditors include employees entitled to arrears of wages, holiday pay, redundancy pay, and other statutory payments up to a statutory limit that increase slightly each year.
A creditors with a floating charge
Assets subject to a floating charge often include stock, raw materials, work-in-progress, fixtures and fittings. Assets of this type can be traded in the normal course of business.
Terms and conditions relating to fixed and floating charges are laid out in a document which is signed by the directors and registered by the lender at companies house.
Prescribed part creditors
The Prescribed Part refers to a ring-fenced fund that must be made available to unsecured creditors in a liquidation procedure (but not administration). This sum is used to provide unsecured creditors with a greater change of recovering some of their debt.
Fifty per cent of the first £10,000 realised from the sale of floating charge assets is set aside in this way, and then 20% of any realisations between £10,000 and £600,000. The remainder is made available for floating chargeholders.
These include trade creditors, utility suppliers, customer, contractors, former employee claims that are not preferential, and HMRC.
Many think that HMRC have a preference but this was abolished in September 2003, which is when the Prescribed Part came into effect.
Once distributions have been paid equally between unsecured creditors, they are entitled to be paid interest on their debt at 8% p.a., before connected unsecured creditors and shareholders receive a distribution.
Connected unsecured creditors
Unsecured creditors associated with the company typically include spouses or other family members of the directors, or perhaps a member of staff who has lent money to the company on an unsecured basis.
Shareholders are the final group to be paid. Because they have taken a business risk in providing money to the company, they are not entitled to a distribution until all other creditor groups have been paid.