A liquidator will (and an administrator may) be required to distribute the assets of the company to its creditors by way of a dividend. This must be done in a specified order of priority in payment in accordance with complex rules. Inconveniently, these rules have no single source: they are found piecemeal in different parts of the IA 1986, the IR 2016, CIGA 2020 and general law. The following (simplified) order of priority in payment summarises the cumulative effect of these rules. This order assumes that that there is a QFC granted on or after the Relevant Date and assumes that where the company obtained a pre-insolvency moratorium, it has paid all moratorium debts and premoratorium debts without a statutory payment holiday which would otherwise have super priority status.
Administrators may also pay dividends to unsecured creditors if they have court permission to do so and the rules set out below will also apply to them. References below to ‘liquidator’ should also be read as including a reference to administrators. It should also be noted that the statutory order of distribution can be affected by priority or subordination agreements entered into by creditors under which one class of creditor agrees to rank behind another.
1. Liquidator’s costs of preserving and realising assets subject to a fixed charge
2- Fixed charge creditors (in respect of assets subject to a fixed charge)
The proceeds of selling assets which are subject to a fixed charge (or mortgage) must first be used to pay off the debt secured by such charge (or mortgage). The proceeds will be paid net of the liquidator’s costs and associated fees of realising the assets (that is, net of sums falling into the first category of priority above). If the proceeds are not sufficient to discharge the debt in full, then the creditor must await payment of the balance at an appropriate later point in the order of priority. This will depend on whether or not the same debt was also secured by a floating charge.
Note that secured creditors with a fixed charge are likely to enforce their security if a liquidator is appointed.
3. Other costs and expenses of the liquidation
This includes all other costs and expenses of the liquidation, including the costs of selling assets secured by a floating charge and the costs and expenses incurred in pursuing litigation. Such litigation will require prior approval from preferential creditors and floating charge holders, or alternatively from the Court, otherwise the liquidator cannot claim the costs of litigation. The reason for this rule is that it is these creditors who will effectively pay the costs of litigation should it fail.
4. Preferential debts (Schedule 6)
Although the EA 2002 removed the preferential status of certain Crown debts, some of these will soon be reinstated. The composition of the categories of preferential debts and their ranking has therefore become somewhat more complex than has been the case for some years.
For insolvencies occurring on or after 1 December 2020, there will be two tiers of preferential debts. The first tier must be paid in full before the secondary tier can be paid.
The first tier consists of the existing categories of preferential debts. The main ones are (i) employees for remuneration due in the four months before the ‘relevant date’ (generally the date of the winding up resolution or petition) but subject to a maximum of £800 per employee, plus accrued holiday pay and (ii) certain contributions owing to an occupational pension scheme. If the insolvent company is a bank or building society, certain retail deposits that are insured by the Financial Services Compensation Scheme will also be preferential debts.
The secondary tier consists of debts due within certain prescribed periods to HM Revenue and Customs in respect of PAYE, employee national insurance contributions and VAT. These represent taxes which companies collect on behalf of HMRC from third parties (employees and customers).
5. Prescribed part fund
The EA 2002 introduced the ‘prescribed part’ fund into the IA 1986 to increase the chance that unsecured creditors would get paid something in a liquidation. The prescribed part fund is sometimes referred to as the “ring fenced” fund.
The prescribed part fund is calculated by reference to a certain percentage (the ‘prescribed part’) of the company’s ‘net property’. This is set aside (ring-fenced) for distribution to the company’s unsecured creditors; s.176A. ‘Net property’ means the proceeds of selling property other than that which is subject to a fixed charge, after deduction of the liquidator’s expenses and any preferential debts. (The full definition in s. 176A (6) IA 1986 states: “… 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 amount of the company’s net property that will be ring-fenced is 50% of the first £10,000 and 20% thereafter up to a maximum fund of £600,000 for floating charges created before 6 April 2020 and £800,000 for floating charges created on or after that date. The ring-fencing provisions do not apply where the net property of the company is less than £10,000 as the cost of distributing the fund would be disproportionate to the benefit; see the Insolvency Act 1986 (Prescribed Part) Order 2003. You will not be required to calculate the amount of a ring-fenced fund on this course. This pot of money is reserved at this stage to be shared rateably among the unsecured creditors when they are paid. It should be noted that for this purpose, a floating charge holder who suffers a shortfall on floating charge realisations does not share in the prescribed part fund, although the shortfall does constitute an unsecured claim against the company.
Note: the ring-fencing provisions only apply to realisations from floating charges created on or after the Relevant Date. The holder of a pre-existing floating charge (created before the Relevant Date) therefore benefits from the abolition of the Crown Preference but does not suffer from the ring-fencing provisions.
6. Floating charge creditors
After payment of the general expenses of the liquidation, paying preferential debts and dealing with the prescribed part, the liquidator then pays any remaining realisations from assets subject to floating charges to the floating charge holders themselves (according to the priority of their security, if there is more than one floating charge holder).
7. Unsecured creditors
For example:
- ordinary trade creditors who have not been paid;
- secured creditors to the extent that the security is invalid or assets subject to the security have not realised sufficient funds to pay off the secured debt; and
- employees’ outstanding remuneration, to the extent that it does not rank preferentially.
All the unsecured creditors rank and abate equally. This is known as the ‘pari passu’ rule. For example, if a company has only two creditors (A and B) and creditor A has a claim against the company of 100 and creditor B has a claim against the company of 50 (making total claims of 150) but the assets available for distribution to the creditors are 75, creditor A will receive 50 and creditor B will receive 25.
Note that secured creditors who have not been paid in full from the realisation of assets subject to their security can only claim as unsecured creditors against realisations from unsecured assets, so they are not eligible to any payment from the prescribed part fund.
8. Interest on unsecured (including preferential) debts
Interest accruing on unsecured debts from the commencement of the winding up.
9. The shareholders
The shareholders who participate in the equity of the company will rank last. However, their rights, as between themselves, will depend on the rights attributable to their particular class or classes of shares. This will be written into the Articles of Association. For example, preferential shareholders may have preferential rights to a return of their capital on a winding up in priority to ordinary shareholders.