Article / 27 May 2022
If you are a creditor of an insolvent company, it is important to understand how asset realisations will be distributed. This quick guide helps to explain the order in which creditors will be paid.
In this article, we look at the “insolvency waterfall”: how asset realisations are distributed in any insolvency process.
When a company goes into administration or liquidation, one of the primary functions of an insolvency practitioner is to realise the company’s assets and distribute those assets to the company’s creditors. But how does the insolvency practitioner decide who to distribute the assets to first? It all depends on where the creditor sits within the ‘insolvency hierarchy’.
The insolvency hierarchy sets out the order in which creditors are to be paid. Each class of creditor must be paid in full before the next class can be paid. Creditors will rank in the following order of priority:
At the top of the insolvency hierarchy are fixed charge creditors. A fixed charge is a form of security that is attached to a specific asset or a specific class of assets which are not usually sold in the company’s ordinary course of business. Examples include security over property, large plant/ machinery and vehicles.
The proceeds of the fixed charge assets must first be used to pay the fixed charge creditors. However, all proper costs, charges and expenses reasonably incurred in the preservation and realisation of the assets (including the insolvency practitioner’s remuneration) may be deducted before the proceeds are paid to the fixed charge creditors.
Fixed charges rank in priority according to the date of their creation, subject to any deed of priority that may have been entered into between two or more fixed charge creditors. Therefore, if there are several fixed charge creditors, the insolvency practitioner will distribute the proceeds of the fixed charge assets to the fixed charge creditors in the order of priority of the charges. However, an insolvency practitioner cannot realise these assets and distribute the proceeds without the consent of the fixed charge creditors.
If the proceeds are not sufficient to discharge the whole debt, any unpaid fixed charge creditors will be classed as unsecured creditors in respect of the outstanding debt. Alternatively, any surplus will flow back into the insolvency estate.
In June 2020, a new moratorium process (the moratorium) was introduced. The moratorium provides a short breathing space for financially distressed companies, as it prevents certain creditors taking enforcement action. However, it is only available to companies where it is likely to result in the rescue of the company. If, within 12 weeks of the end of the moratorium, a company goes into administration or liquidation, then all priority pre-moratorium debts and moratorium debts obtain ‘super priority’. They will rank second in the insolvency hierarchy.
Broadly, moratorium debts are debts which are incurred during the moratorium or after the moratorium in connection with an obligation incurred during the moratorium.
Priority pre-moratorium debts are a limited category of specific debts which were incurred before the moratorium but not paid; for example a debt payable in respect of goods and services supplied during the moratorium or rent falling due during the moratorium.
The insolvency practitioner will incur expenses in the course of administering an insolvent estate, realising assets and distributing proceeds. Examples include: the insolvency practitioner’s professional fees, any legal fees incurred in connection with the administration/ liquidation, and the costs incurred in managing the business of the insolvent company. These expenses will be paid from any surplus fixed charge realisations and/ or floating charge realisations. However, the insolvency practitioner’s remuneration is subject to creditor approval.
Preferential debts are unsecured debts that are given preferential status in law. This includes: contributions to occupational and state pension schemes, wages and salaries of employees for work done in the four months before the insolvency date (up to a maximum of £800 per employee), and certain debts owed to HMRC.
Before the insolvency practitioner can distribute proceeds to the floating charge creditors, they must (subject to de minimis rules) carve out the prescribed part for distribution to unsecured creditors. This rule ensures that the unsecured creditors might receive some dividend from the estate.
The prescribed part is calculated as a percentage of floating charge realisations, namely 50% of the first £10,000 of floating charge realisations and 20% thereafter, subject to a cap of £800,000 where the floating charge is created on or after 6 April 2020, or £600,000 where it was created before then.
Once the insolvency practitioner has carved out the prescribed part, it will then pay the floating charge creditors from the remaining floating charge realisations. A floating charge is a form of security that is attached to a class of non-constant assets that may change in quantity and value. Examples of floating charge assets include: stock and inventory, trade debtors, furniture, fixtures and fittings.
The insolvency practitioner pays floating charge creditors according to the priority of their security.
The insolvency practitioner will pay unsecured creditors on a pari passu basis from a combination of any remaining asset realisations and the prescribed part. Pari passu means that all the unsecured creditors will receive a pro-rata payment depending on the size of their debt.
Common examples of unsecured creditors include: suppliers, employees, contractors and customers.
If there are sufficient funds, once unsecured creditors have been paid in full, creditors are entitled to be paid statutory interest accrued after the commencement of the insolvency on any provable debts. The current statutory rate of interest is 8% plus the Bank of England base rate.
The shareholders of the company sit at the bottom of the hierarchy and are the last to be paid in a company insolvency. Shareholders will only receive payments after all the previously listed creditors have been repaid, and only if there is any surplus remaining. This is not common in most insolvencies and tends only to occur in solvent liquidations whose purpose is to return funds to shareholders. Where different classes of shares exist, any payments made to shareholders will depend on the rights attributable to their class of shares.
The estimated outcome for creditors and an analysis of the prospective insolvency hierarchy is critical during the planning process in determining whether there are restructuring solutions which drive better creditor value than insolvency.