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Who Gets Paid First In Liquidation?

This guide explains who gets paid first in a Liquidation and how the Liquidator shares the assets amongst creditors.

In this guide you’ll learn:

  • How the assets of a Liquidation are shared.
  • The pari passu basis of asset sharing.
  • Which creditors get paid first.
  • What happens to the shareholders’ share.

Let’s get started.

Who Gets Paid First In Liquidation?

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Who Get The Assets First In Liquidation?

A Liquidator has to share the assets of a Liquidation in accordance with legislation. This is known as the statutory order of payment in an insolvency case.

The costs and expenses of a Liquidation are paid first and then creditors are paid in accordance with the statutory scheme.

How Are The Assets Of A Liquidation Shared?

The assets of a Liquidation are shared amongst the creditors by a Liquidator on a pari passu basis. However, before they are shared out amongst the creditors they have to be first used to pay the costs and expenses of the Liquidation.

The costs and expenses of a Liquidation are subject to their own order of payment in the legislation and they are paid first. In simple terms the costs of litigation and other asset realisations are paid first, then the petitioning creditor’s costs for the petition (if it is a Compulsory Liquidation), then any legal costs and then the fees of the Liquidator.

How Does The Pari Passu Basis Determine Who Gets Paid First In Liquidation?

The pari passu basis of the distribution of the assets by a Liquidator is where the assets are shared on an equal basis amongst the creditors but first the costs and expenses are dealt with.

Which Creditors Get Paid First In Liquidation?

The assets of a company in Liquidation are divided amongst creditors equally but in accordance with each category of creditors’ rights.

In the most simplistic terms, secured creditors with a fixed charge are paid before preferential creditors who are paid before unsecured creditors. However, even that is subject to further rules that determine how the Liquidator distributes the assets amongst the various creditor classes.

What Are the Categories Of Creditors In A Company Liquidation?

The categories of creditors in a company Liquidator are:

  • Secured Creditors
  • Preferential Creditors
  • Unsecured Creditors
  • Prescribed Part

Ranking Order Of Payment Of Creditors

Creditors are ranked as follows:

  1. Secured creditors with a fixed charge
  2. Administrator/Liquidator fees
  3. Preferential creditors
  4. Secondary preferential creditors (now expanded to include HMRC for certain taxes)
  5. Prescribed part unsecured creditors (see explanation below)
  6. Secured creditors with a floating charge
  7. Unsecured creditors (including all other HMRC debt)
  8. Shareholders

What Are Secured Creditors?

Secured Creditors are creditors such as for example banks or asset-based lenders who have specifically obtained security over some or all of the company’s assets by way of a legal charge or a debenture giving them priority over other creditors. This means that when those secured creditors agreed to provide funds to the company they did so having entered into an agreement that they required such priority and upon realisation of those assets in the event of insolvency. Such charges will commonly be a fixed and or a floating charge over the assets of a company.

Secured Creditors with a ‘fixed’ charge over an asset reign supreme and rank right at the front of the queue in Liquidation to be paid. Upon insolvency, an asset subject to a fixed is really owned now by the fixed chargeholder.

A fixed charge is attached to an asset and can be easily identified. A floating charge is a charge that floats above assets that constantly in effect change.

Subject to the Prescribed Part and Preferential Creditors (see below) the Secured Creditors with a ‘floating’ charge will be paid ahead of other creditors ie. the Unsecured Creditors.

If a charge has not been delivered to Companies House within 21 days of its creation then the charge is void against the Liquidator so it is important to get the formalities correct as this could affect how the assets are shared in a Liquidation.

Who Are Preferential Creditors?

The Preferential Creditors are those creditors who are entitled to preference when the assets are shared in the event of a distribution by the Liquidator. They are referred to in Section 175 of the Insolvency Act 1986 and are paid ahead of secured creditors with a floating charge in light of Section 175(2) of the Insolvency Act 1986.

Preferential Creditors are employees and H M Revenue and Customs (“HMRC”) in respect of arrears of VAT and PAYE. Preferential Creditor claims rank ahead of the unsecured creditors but not necessarily for the full sum owed to a Preferential Creditor.

Employee creditor claims that are preferential are:

  • outstanding salary (including commission) for the previous four months, up to a maximum of £800 in total
  • Accrued holiday pay of up to six weeks
  • Some occupational pension payments

Only certain specified HMRC debts are included. These are:

  • Value Added Tax (VAT)
  • debts that relate to the following taxes:
    • Pay As You Earn (PAYE) Income Tax
    • employee National Insurance contributions (NICs)
    • students loan repayments
    • Construction Industry Scheme deductions

Where the business is required to deduct these taxes from payments they make to another other person and pay those deductions to HMRC and the payment to HMRC is credited against the liabilities of the other person.

Who Are The Unsecured Creditors?

The Unsecured Creditors are in effect everyone else and they are all treated the same. They do not have any priority rights available to them other than those arising from the Prescribed Part.

What Is The Prescribed Part?

The Prescribed Part is a ring-fenced fund arsing from what is referred to as the ‘net property’ that must be made available to unsecured creditors in a Liquidation or Administration which instead of being paid to a bank under its (floating) charge is instead ring-fenced to be paid to unsecured creditors. The net property is defined in Section 176A(6) of the Insolvency Act 1986 as:

In subsections (2) and (3) a company’s net property is the amount of its property which would, but for this section, be available for satisfaction of claims of holders of debentures secured by, or holders of, any floating charge created by the company.

The overall sum available for distribution (after paying off secured creditors and preferential creditors) must be divided into two parts being:

  • That prescribed part which must be made available to unsecured creditors.
  • The balancing sum which is then available for the floating charge holder

The “prescribed part” is calculated under Section 3 of The Insolvency Act 1986 (Prescribed Part) Order 2003:

  • 50% of the first £10,000 of the sum and
  • 20% of the balance.

The value of the prescribed part of the company’s net property to be made available for the satisfaction of unsecured debts of the company pursuant to Section 176A of the Insolvency Act 1986 shall not exceed £800,000.

The prescribed part can be set disapplied if the net property is less than £10,000 in light of Section 2 of The Insolvency Act 1986 (Prescribed Part) Order 2003 and the Insolvency Practitioner thinks the cost of making a distribution to unsecured creditors would be disproportionate.

What About The Shareholders’ Share Of The Assets?

If there are sufficient realisations available after the Unsecured Creditors have been paid in full with interest, and there is a surplus, then this will be distributed amongst the shareholders in accordance with their rights. This is a relatively rare event in an insolvent Liquidation but does happen.

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Disclaimer: Who Gets Paid First In Liquidation?

This post: Who Gets Paid First In Liquidation? is not legal advice and should not be relied upon as such. Who Gets Paid First In Liquidation? is provided for information purposes only. You can Contact Us on the specific facts of your case to obtain relevant advice via a Free Initial Consultation.