Who gets paid first when a company goes into liquidation?
When a company goes into liquidation, an official receiver is appointed to oversee the sale of the remaining assets of the company.
The job of the company liquidator is to obtain the best possible value for the creditors of the company in return for the debts.
The thing to remember is that at this point the company is insolvent anyway – this means that it doesn’t already have the cash to pay off its creditors, its balance sheet is showing an excess of liabilities over assets and that there is no possibility of trading out of the situation.
This means that before the process even starts there is a strong likelihood that creditors won’t get back what they are owed.
Where does the money go?
The first payments out of the pot go to the liquidator. There’s a simple and practical reason for this. Let’s be honest, no-one is going to take on the job of liquidating a company if they know they aren’t going to get paid, so to ensure a professional will be available to actually do the job, the insolvency practitioner is allowed to take their fee first.
Some creditors will have taken a charge over some or all of the assets of a company, in which case they come at the top of the pile of creditors for payment.
A charge is a legal agreement that the creditor in question almost ‘owns’ the value of an asset so that it can’t be sold without their direct agreement and that they get paid the money from the sale.
There are two types of charges – a fixed charge and a floating charge.
The easiest to understand and administer is the fixed charge. This is taken on a specific asset. The best known of these will be a mortgage on a house. If the house gets sold then the mortgage is paid off first and then any money left over is returned to the owner of the house.
In the same way, a company may have given a charge over their premises, machinery or vehicles in order to get a loan to buy them. The creditor, in this case, gets paid from the sale of the asset.
A floating charge can be taken over a group of assets or all the assets of the company. For example, a car rental company may give a floating charge over all the vehicles in its fleet or business may take a bank loan that includes a charge on all of the assets held of the company.
Although a floating charge isn’t on specific assets it still works in the same way as a fixed charge. That means that once they are sold, the value realised from the assets is first given to the charge holder and then the remainder is distributed to the other creditors.
There are some nuances here around the collection and since 2003 part of the value needs to be set aside for unsecured creditors. If you are unsure what will happen in your specific case then you should take advice.
One of the best-known aspects of insolvency was the requirement that HMRC had the status of a preferential creditor. This was abolished in 2003 and now HMRC ranks alongside other unsecured creditors.
However, employees still retain the preferential status and this means that they rank just behind secured creditors in the chain for payment of salaries and holiday pay.
Next up come the creditors that have unsecured status.
The pot that remains gets shared on a pro-rata basis across the whole of the debt that remains. This share out or ‘dividend’ is usually only a few pence on the pound by the time it gets to this point especially if the company had a number of secured creditors.
Almost last in line comes what is called connected creditors.
A connected creditor is one that is connected to the firm, be they directors, employees or family of directors that have lent to the business on an unsecured basis.
Technically called an ‘associate creditor’, even if they have the legal ranking in the order of payment, these people are unlikely to receive a dividend in practice.
Last in line come the shareholders.
It may seem somewhat harsh that the people that put their money into the company to get it started and support it along the way are then likely to receive nothing in the event of a liquidation.
Of course, the plain fact is that when the shareholders bought into the business they were taking a gamble. It may have been a calculated one but if things turn out worse then they have to accept the loss of their investment as the likelihood of a dividend at this point is virtually nil.
Liquidation is the last option when a business gets into trouble and so every effort is made to find a different solution. That having been said if you find a debtor of yours going down this route you’ll now hopefully be able to find where you are in the order of payment.