Who Gets Paid First when a Company Goes into Liquidation?May 16, 2019
During liquidation, the liquidator sells off a company's assets and distributes the funds to its creditors. However, the liquidator must pay creditors in a very precise order.
The simplest way to think of the order is as a set of stairs. At the top are the most important creditors, who must be paid before everyone else. Once all the most important creditors have been paid, the liquidator can take a step down and start paying the next most important creditors. That process continues until the company's money has run out.
In this article, we'll look at the order of priority of distribution in more detail, discussing what creditors fall into what categories. Let's get started.
The liquidation order of priority
As we mentioned earlier, the liquidator must follow strict rules when distributing funds to creditors. If you have some time on your hands, you can read through the full rules in The Insolvency (Scotland) (Receivership and Winding up) Rules 2018.
If you don’t have time, here’s an abbreviated version of the order of priority in distribution:
- Secured creditors
- Expenses of the liquidation
- Preferential creditors
- Ordinary creditors
- Interest on preferential debts and ordinary debts
- Company members
In the next few sections, we’ll take a look at each of these categories in more detail, discussing what kind of debts fall into which category.
At the top of the list are secured creditors. These creditors have a legal right (also called a charge) over a particular asset and these debts must be paid before all others.
For example, if a business took out a mortgage on a warehouse, the bank has a right over the property asset. If the business goes bust, the liquidator must ensure that the bank gets their asset back.
Liquidators dedicate significant amounts of time to managing each liquidation and they must be paid for their knowledge and experience. These fees must be agreed with the company’s creditors at the start of the insolvency.
The liquidator’s fees are prioritised above other debts to ensure there is an experienced and knowledgeable individual managing the process, which, in turn, maximises the amount of money other creditors receive.
Preferential debts are held by preferential (or preferred) creditors. These debts must be paid before ordinary debts. The largest group of preferential creditors is employees, who are usually first in line to get paid. Up until 2002, HMRC was considered a preferential creditor but the Enterprise Act 2002 relegated HMRC to the ranks of ordinary creditors. However, HMRC will soon be considered preferential creditors once again. When Philip Hammond was still the Chancellor, he announced the return of HMRC as a secondary preferential creditor - this change is scheduled to come into force in April 2020.
Ordinary debts, owed to ordinary creditors, include almost everything that isn’t a secured or preferential debt. Typically this covers people and organisations like suppliers, contractors, currently HMRC (HMRC will return as preferential creditors in April 2020) and particular staff claims.
Since liquidations often involve struggling companies, it’s likely that they have overdue preferential and ordinary debts amassing interest charges. If there is any money left after the liquidator has paid the secured creditors, liquidation expenses, preferential creditors and ordinary creditors, he or she may pay out interest on those debts.
Finally, once all other creditors have been paid, the liquidator can start distributing funds to company members. Which company members get paid first depends on a number of factors, including specific shareholdings and company rights.
In an insolvent liquidation, it’s unlikely there will be much money left by this point as the company was already in financial difficulties.
However, a members’ voluntary liquidation is an excellent way to extract value from a solvent company when the shareholders wish to retire or move on. During solvent liquidations, there is usually a substantial amount of money left to be distributed to company members.
Is your business in trouble?
Ultimately, the effectiveness of any liquidation will come down to the skill and experience of the insolvency practitioner managing it. If you choose the right person and give them enough time, they will be able to maximise returns from the liquidation, which is the best outcome for both shareholders and creditors. If you require assistance with a liquidation, contact our contact our office for free, confidential advice.