Creditors In A Voluntary Liquidation – Who Gets Paid First?

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When a company is placed into a voluntary liquidation process, be it an MVL or a CVL, a licensed insolvency practitioner is appointed as the Liquidator of the company. The Liquidator is initially nominated by the shareholders, however, creditors may nominate an alternate insolvency practitioner to act as Liquidator should they see fit. For more information on the process of placing a company into voluntary liquidation, please read our article covering the matter.

The Liquidator has a duty to act in the best interests of creditors. It is therefore important that the insolvency practitioner maximises the realisation of available assets and conducts a proper investigation as regards the financial affairs and transactions of the company. It is possible that further realisations will be achieved as a result of the Liquidator’s investigations.
If there are funds that remain in the liquidation after all appropriate costs have been discharged, these are available to distribute amongst creditors in the following order:

  1. Secured Creditors (Fixed Charge)
  2. Preferential Creditors
  3. Secondary Preferential Creditors
  4. Secured Creditors (Floating Charge)
  5. Prescribed Part – Unsecured Creditors
  6. Unsecured Creditors

Secured Creditors

It is common for banks or other finance companies to obtain security over the assets of a company when a loan or other facility is provided. Any creditor can obtain security over assets with the consent of the company.

The security obtained by the creditor is typically in the form of a debenture that you will be able to view at Companies House. The security will either confer a fixed charge over a single or group of assets, a floating charge over all assets, or both. Other forms of fixed charge security, such as a hire purchase agreement on a motor vehicle, do not need to be filed at Companies House.

If a creditor has a fixed charge over an asset it means that they exercise some degree of control over that assets, so much so that the company cannot dispose of it without the charge holder’s consent. The prime examples here is a property subject to a mortgage, or, as identified above, a car purchased subject to finance.

When an asset held subject to a fixed charge is sold in a voluntary liquidation process, it is treated in the same manner as if an active company looked to sell the asset. The secured creditor is paid first from the realisation.

In contrast, a floating charge is a term given to security that is not held over a specific asset but more so it ‘floats’ over all assets. When a company is placed into voluntary liquidation, that floating charge security crystallises. The effect of this is that the creditor now ranks as a floating charge creditor in the liquidation process.

Preferential Creditors

When a company ceases to trade it is necessary for all employees to be made redundant. Employees have various rights in an insolvency process, as covered in our previous article – Employee Rights Under Insolvency – What Can you Claim?

To summarise, there are two claims that can be made by a former employee that rank as a preferential creditor in a liquidation process. These claims consist of arrears of wages (capped at £800 per employee) and any unpaid holiday entitlement.

In practice, the employees will claim any sums due (including other statutory claims which rank as unsecured claims) from the Redundancy Payments Service following the appointment of the Liquidator. The insolvency practitioner will provide the employees with all the necessary information in order to lodge a claim.

If the Redundancy Payments Service pay the employees any element of their arrears of wages or holiday entitlement, they will effectively stand in the shoes of the employee and rank as a preferential creditor in the liquidation.

Secondary Preferential Creditors

From 1 December 2020, HM Revenue & Customs rank as a secondary preferential creditor in any insolvency proceedings. Prior to 1 December 2020, HMRC ranked as an unsecured creditor.

For simplicity, the amount that HMRC can claim as a secondary preferential creditor is effectively all unpaid taxes (for example VAT, PAYE or National Insurance Contributions) except corporation tax. As can be demonstrated from the order of payments in a voluntary liquidation process detailed previously, this puts HMRC in a much better position than they would have been previously.

Prescribed Part

The ‘prescribed part’ refers to a sum of funds that would have typically been made available to floating charge creditors (4th in the list), which are ring-fenced for the benefit of unsecured creditors. This applies to all floating charge security dated on or after 15 September 2003.
The prescribed part is calculated by taking the ‘net property’ – being the sum of money available after preferential creditors (and secondary preferential creditors) have been paid in full – and applying the following formula:

  1. 50% of the first £10,000
  2. 20% of all funds thereafter
  3. Capped at £800,000 (as of 6 April 2020)

The balance of the net property, after deducting the prescribed part, is payable to the floating charge creditors. No deduction of the prescribed part is made where the floating charge security predates 15 September 2003.

Unsecured Creditors

The term ‘unsecured creditors’ effectively refers to everyone else that is owed money by the company that does not benefit from any form of security or preferential status pursuant to insolvency legislation.

Unsecured creditors will include trade suppliers, employee claims for anything other than those which rank as preferential, connected party loans …. the list goes on.

When a company enters a creditor’s voluntary liquidation (CVL), it is often perceived that there is little if any prospect of unsecured creditors receiving a dividend. Whilst this can often be the case, it is still worth unsecured creditors lodging claims with the Liquidator as there may still be a chance of recouping funds. For those creditors who are unfamiliar with the insolvency process, we would strongly recommend using our free creditor services offering.

What About Shareholders?

When all classes of creditor have been paid in full they are entitled to statutory interest at a rate of 8% per annum, running from the date of liquidation to the date of payment. If there are still funds remaining, these are available for the Liquidator to distribute to the shareholders of the company.

It is uncommon for a distribution to shareholders to occur in a creditors voluntary liquidation, as this would imply that the company is in fact solvent. The correct process to use to liquidate a solvent company is a member’s voluntary liquidation (MVL).

An Example of the Distribution of Funds in a Voluntary Liquidation

  1. XYZ Limited has entered a creditors voluntary liquidation process.
  2. It owns a freehold property currently worth £500,000 subject to a mortgage due to ABC Bank. The balance due to ABC Bank is £600,000. ABC Bank also holds a debenture conferring a floating charge over all other assets, dated 01.01.2017.
  3. Other assets (not subject to any fixed charge security) sell for £q200,000.
  4. Former employees have preferential claims totalling £50,000 relating to arrears of wages and holiday pay.
  5. HMRC are owed £75,000 in respect of VAT, £10,000 in respect of PAYE/NIC and £60,000 in corporation tax. All other creditors are owed £700,000 collectively.

The flow of funds in the liquidation of XYZ Limited will be as follows:

flow of funds in the liquidation of XYZ Limited (Hypothetical Blog Example)

Any Questions?

If you are a director of a company looking for further information on the rights of creditors or generally looking to enquire in respect of the voluntary liquidation process, please contact us.

Equally, if you are a creditor looking to understand where you rank in an insolvency process or wish to explore our creditor services offering, don’t hesitate to get in touch.

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