Creditor Order of Priority
The ultimate aim of an insolvency procedure is to return as much money as possible to an insolvent company or individual’s creditors. Unfortunately, because of the nature of insolvency, there is usually not enough money available to repay everyone what they are owed. To help manage competing creditors’ claims, creditors are repaid in a strict hierarchy set out by legislation. Each tier of creditors must be paid in full before repayments can be made to the next tier.
(1) Fixed charge’ creditors: Creditors whose lending to a company or individual is secured against a definable object (e.g. a mortgage on a building/warehouse, or a fixed piece of equipment).
(2) Insolvency process costs: Including wages or rent due during the process, professional and legal fees incurred, and the fees and expenses of the office holder (a licensed insolvency practitioner or the Official Receiver)
(3) Preferential creditors: This currently covers some payments due to employees, and money owed as part of the Financial Services Compensation Scheme. As of 1 December 2020, certain HMRC tax debts owed by a company or individual on behalf of others (e.g. VAT or PAYE debts owed by a company, or VAT owed by an individual in relation to business activities) now fall within the category of preferential debts. However, all other preferential debts must be paid in full before HMRC can receive a distribution.(Read more here)
The ultimate aim of an insolvency procedure is to return as much money as possible to an insolvent company or individual's creditors. Unfortunately, because of the nature of insolvency, there is usually not enough money available to repay everyone what they are owed. To help manage competing creditors' claims, creditors are repaid in a strict hierarchy set out by legislation. Each tier of creditors must be paid in full before repayments can be made to the next tier.
(4) Floating charge creditors: Creditors whose lending is secured against a class of asset (e.g. ‘stock’ in a warehouse, but not specific items of stock).
a. The Prescribed Part: In order to increase the chances of returns to unsecured creditors, the Enterprise Act 2002 created the ‘Prescribed Part’. This is a pot of money set aside from what would have been paid to floating charge creditors so that a repayment can be made to unsecured creditors instead. The Prescribed Part is calculated as 50% of the first £10,000 due to be repaid to floating charge creditors, and then 20% of floating charge creditor returns up to a total cap of £800,000.
(5) Unsecured creditors: This category covers almost all other creditors, including pension schemes, customers and trade creditors. Tax debts owed by an insolvent company or individual themselves (such as Corporation Tax or Self-Assessed Income Tax) fall into this category.
There are also detailed rules around what creditors may or may not claim, and how costs and expenses must be prioritised when there are insufficient funds to meet them, alongside regulations that insolvency practitioners must apply to the approval of their own fees and costs, the way they handle the funds under their control, and the financial information that they must produce to explain how funds have been applied.
In addition to their rights in relation to the order of priority in an insolvency procedure, creditors have a number of other rights including: to form a committee; to be kept informed or opt out of being kept informed; to participate in decision procedures; and to ask for further information about or to challenge an insolvency practitioner’s fees, where they believe them to be excessive.
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