On 22 July 2020 the Finance Bill gained royal assent giving rise to the Finance Act 2020. Below, you will be taken through an overview of how creditors are paid in an insolvency process as well as how two of the key changes could affect your business going forward.
How Are Monies Distributed to Creditors in an Insolvent Company?
The insolvency regime sets out a strict order of preference, a statutory waterfall that ranks creditors based on the strength of their claim. The order of preference exists to divide the residue of an insolvent estate between creditors on a pari passu (on equal footing) basis.
Those with valid fixed charge security or proprietary right to assets held by the company such as a Quistclose trust or an express trust have first ranking claims. This ensures that a lender such as a bank with a registered mortgage or fixed charge is paid from money generated from the sale of the secured asset less the fees and administrative expenses connected with the realisation of that asset of the appointed insolvency practitioner. This payment is limited to the proceeds of the relevant asset and does not include any realisations made from unsecured assets, which are available to creditors of the company as a whole.
Second ranking payments are the expenses of the insolvent estate. These include expenses incurred when trading an insolvent company and those from the preservation of assets, which rank in priority to the second ranking expense of the insolvency practitioners fees and disbursements.
The third ranking payments are those of preferential creditors, such as employees with outstanding wages up to £800, holiday pay and some pension scheme contribution liabilities.
Fourth ranking payments begin with the Prescribed Part, for which the following statutory calculation exists:
3.(1) The Prescribed Part of the company’s net property to be made available for the satisfaction of unsecured debts of the company pursuant to section 176A of Insolvency Act 1986 shall be calculated as follows—
- where the company’s net property does not exceed £10,000 in value, 50% of that property;
- subject to paragraph (2), where the company’s net property exceeds £10,000 in value the sum of—
- 50% of the first £10,000 in value; and
- 20% of that part of the company’s net property which exceeds £10,000 in value.
(2) The value of the prescribed part of the company’s net property to be made available for the satisfaction of unsecured debts of the company pursuant to section 176A shall not exceed £600,000.
After the net property subject to a floating charge has had the prescribed part removed, the remainder is available for distribution to floating charge holders. A floating charge can be held over any company asset, such as work in progress, stock, plant and machinery and any asset not subject to a fixed charge.
The remainder of unsecured assets and the prescribed part form the pool from which unsecured creditors are paid as a fifth ranking claim on a pari passu basis, which means they receive a fixed repayment of X pence in the pound in proportion to the size of their claim. A secured creditor who was not repaid in full from the sale of the secured asset can claim for the shortfall in the insolvent estate as an unsecured claim. The prescribed part, however, cannot be used to repay a shortfall, its repayment must come solely from the realisation of unsecured assets. The Crown currently ranks as an unsecured creditor for claims for unpaid taxes.
In the unlikely event that after the payment of all creditors a surplus of funds exists, the surplus is distributed to the company shareholders. This is a sixth ranking claim.
What happened to Crown Preference?
In s 252 Enterprise Act 2002, the preferential status of crown debts for unpaid taxes was abolished. Prior to this HMRC debts in the 12 months for Pay-as-you-earn tax (PAYE) and National Insurance Contributions (NICs) and 6 months for Value Added Tax (VAT) leading up to insolvency were preferential and were a third ranking payment. The government wished to encourage a more positive shift in perspective from the doom and gloom of insolvency being synonymous with company death to the idea of restructuring, rescue and recovery and to instil a survival culture amongst struggling UK businesses. By lessening the burden of tax debts, more of the money generated realising assets were available to floating charge holders and unsecured creditors. This was intended to encourage enterprise and allow asset-based lenders to have more confidence in the security of a floating charge and thus lend more readily.
In my next blog I will be discussing the return of Crown preferential status alongside other key changes. If you would like to discuss this further or need advice please do not hesitate to get in touch with a member of our Insolvency Team.
