When liquidating an insolvent company, the funds raised from selling assets primarily go to meeting the needs of creditors. While simple enough, the process gets a bit more complicated when a company has a variety of creditors. Some must be paid before others, creating a debt hierarchy, so to speak. If you intend to liquidate your company in the future, it is essential to know this hierarchy and who preferential creditors are.
What are preferential creditors?
Preferential creditors, sometimes referred to as preferred creditors, are creditors that must be paid before any other. The order in which preferential creditors must be paid is detailed in the Insolvency Act 1986. It also has information regarding secured and unsecured creditors, and where they fit into the payment order.
Preferential creditors are of middling importance, being paid after secured creditors, but before unsecured creditors. Secured creditors come first as company-owned assets are used as collateral, or held under a fixed charge.
What is the priority of creditors during liquidation?
As we mentioned, payment of creditors must follow a specific order during the liquidation process. This order is as follows:
- Fees for your appointed insolvency practitioner and costs of the liquidation process
- Secured creditors
- Preferential creditors
- Creditors with a floating charge
- Unsecured creditors
- Shareholders and preferred shareholders
Depending on how much money is realised from company assets, some or all of these creditors can receive payment. If a company does not have enough funds to repay everyone, some debts can be written off. However, if the directors have signed a personal guarantee, they can be held personally liable for repayment.
Who are preferential creditors?
There is a wide range of preferential creditors, from company employees to victims of wrongful action. Below are preferential creditors in more detail:
The first and most important preferential creditor is company employees. They have devoted a considerable amount of their time and effort to the company being liquidated, and so have priority over other types of preferential creditors. A company will be expected to pay any unpaid wages up to £800, in addition to pension contributions and any holiday pay they may be entitled to.
A dismissed employee can appeal to the employment tribunal for a protective award in some instances. For example, if an employer has not done their due diligence, neglecting to consult the appropriate parties before dismissing an employee, then said employee can take legal action. If successful, the tribunal can make an award, which will fall under the category of preferential payment.
If a company has engaged in wrongful trading, and a damaged party has filed a lawsuit, the company must pay damages. These parties that commence legal action are known as tort victims, and are classed as preferential creditors.
Financial Services Compensation Scheme (FSCS)
The FSCS is an organisation that aims to protect customers if a company fails. If the company cannot pay what is owed to its customers, they can lodge a claim with the FSCS to recoup some or all of their money, provided it does not exceed £85,000.
The FSCS has somewhat recently undergone changes. In 2014, customers that had deposits tied up in a failed company were classified as preferential creditors, again assuming the amount owed was not in excess of £85,000. This is thanks to The Banks and Building Societies Order implemented in the same year, adding what is essentially a new class of preferential creditor. In 2015, this new class of preferential creditor was introduced and applied to FSCS clients. This class is called secondary preferential creditors. Naturally, secondary preferential creditors will be paid after primary preferential creditors.
If a company has been found to have polluted excessively, it could lead to more charges being levied against it. While certainly a novel category of expenses for an insolvent company, with a landmark case being held in 2019, it is one that could prove quite impactful for companies. In practice, this will compel companies to pay the cost of cleaning up whatever damage they have caused to the environment. In the landmark case, Rattan v Natural Resource Body for Wales, the judge had given this environmental cleanup cost the highest priority, ranking higher than even secured creditors.
Does HMRC count as a preferential creditor?
HMRC has had several changes regarding its classification over the years. Before 2002, HMRC was considered a preferential creditor. However, changes to the Enterprise Act in 2002 removed this classification, effectively making HMRC an unsecured creditor. This made it much more difficult for HMRC to collect on their debts, including National Insurance contributions, VAT, and PAYE. This problem was noticed and later addressed in the following change.
In 2020, the implementation of the new Finance Act 2020 saw further changes to the classification of HMRC. It recategorised HMRC as a secondary preferential creditor, largely as a means to make tax collection from insolvent companies more efficient. As a secondary preferential creditor, HMRC can receive what it is owed after the primary preferential creditors have been paid. While this change has made it considerably easier for HMRC to collect on its debts, it has no effect on the collection of taxes, such as corporation tax. For those, HMRC remains an unsecured creditor.
This change is a significant one, both for HMRC and unsecured creditors. Of course, HMRC is better able to collect the money that is owed to them, but as they must be paid before unsecured creditors, it can be considerably impactful for the latter.
Clarke Bell can help
If you have decided to pursue liquidation for your company, then allow Clarke Bell to help you through it. We have over 28 years of experience in helping companies close efficiently, while ensuring their obligations to creditors are met. We would be happy to do the same for you, and take that stress off your shoulders. To find out what our experts can do for you, don’t hesitate to contact our team today.