When the directors of a business recognise that the company can no longer pay its debts when they fall due, they can decide to voluntarily cease activity and put the company into liquidation to sell or realise the assets to turn this into liquid funds that are necessary to pay creditors. This is known as a creditors’ voluntary liquidation, or CVL.
During the process of liquidation, creditors are paid in an order of priority determined by law. This order begins with fixed charge creditors (assets where creditors can recover their debt directly from the sale of the asset), and finishes with shareholders, who often see little or no monies because of the priority parties before them.
Determining whether or not a creditor will be paid will be dependent on which part of the order of priority they fall into, and the amount of debt the liquidated company has to account for.
What does a CVL mean for creditors?
As mentioned, a CVL is actioned by the directors when a company is recognised as being insolvent. This means the directors are acting responsibly and are completing their legal duties to creditors by liquidating the company assets to pay off their debts.
In comparison to compulsory liquidation, where a company is forced into closure and directors have no control over proceedings, a CVL often allows for processes to be completed more efficiently, as the directors are more likely to be forthcoming with information on company assets and affairs. This can aid the insolvency practitioner in the liquidation process to maximise returns, and in turn, potentially provide more return for creditors.
The following order of priority applies to all types of liquidations.
Order of priority – The creditors waterfall
1. Fixed charge (secured) creditors
Fixed charge creditors are the first to be paid during a liquidation, as they hold security over a specific asset. Assets such as property, vehicles, and machinery can be paid directly from the selling of that asset, so once it is liquidated, monies can be returned to the creditor. In the event of any shortfall, this then becomes an unsecured debt, which is paid last in priority if any monies are left.
2. Insolvency practitioner fees and expenses
As the practitioner is the one to handle the majority of the liquidation process, they are to be paid from the monies generated by the selling of general assets (assets not subject to a fixed charge) before other creditors. Along with practitioner fees, any legal costs, valuations and other expenses as a result of the liquidation process are also paid at this stage. Please note that the liquidator will need to obtain approval from the creditors or Court before they draw any fees.
3. Preferential creditors (employees)
As employees are considered as potentially vulnerable due to the liquidation they may not have had any say in, they are considered as preferential creditors and are entitled to unpaid wages (up to £800), holiday pay, and pension contributions that the company owes but hasn’t paid. Employees can also claim statutory redundancy pay from the Redundancy Payments Service (RPS), a government-funded scheme that operates separately from the liquidation process. The RPS will effectively pay and take the place of the employees and make their claim in the liquidation.
4. Second preferential creditors (HM Revenue & Customs ‘HMRC’)
HMRC holds preferential status for taxes collected on behalf of others, including VAT, PAYE, employee NICs, and CIS deductions. Other HMRC debts including corporation tax and employer NICs are treated as unsecured debts and are paid later in the priority order.
5. Floating charge creditors
Unlike a fixed charge which is tied to a specific asset, floating charges refer to company assets where the asset may change over time. Stock, banked cash, and general inventory are all examples of assets which may have floating charges because the charge will cover what exists at any given time. Stock gets sold and replaced, cash moves in and out, inventory changes, and the charge covers whatever happens to exist at any given time, which is what distinguishes it from the fixed nature of a fixed charge.
When a company goes into liquidation, floating charges ‘crystallise’, meaning they fix onto whatever assets fall within their scope at that point in time. The floating charge creditor then can claim on these assets once the previous priority creditors have been paid.
It must be noted that floating charge creditors are only paid with the remaining monies after the prescribed part is carved out for unsecured creditors. This sum of money is taken from the overall ‘pot’ in order to ensure that unsecured creditors do get at least an amount of return from the company’s liquidation. Usually, this prescribed amount is capped at £600,000.
6. Unsecured creditors
The largest group to be paid in the order of priority, unsecured creditors may receive a small dividend from the previously mentioned prescribed part of the liquidation monies. Unsecured creditors are those who are owed money by the company, but don’t actually hold any form of security over its assets. Because these creditors don’t have a fixed or floating charge to fall back on, the goods and services they provide are purely based on trust, but give them no higher priority for their debt to be paid.
Trade creditors, utility companies, deposit customers, unsecured lenders, director loan accounts and corporation tax all fall under unsecured creditors, and may not receive much, or even anything once their turn for payment comes.
7. Shareholders
The last to be paid in the order of priority are the shareholders. These individuals are only paid in the instance that all other creditors are satisfied, which is often rare in insolvent liquidation.
What to do if your business is insolvent
In the event your business cannot pay off its debts as they fall due, it’s recommended you speak to an experienced insolvency practitioner for advice. Not all instances of insolvency result in liquidation, and there could be additional routes your company could take to prevent further losses and potentially settle debts without the need for closure.
Speak to a practitioner at Revive Business Recovery for free, impartial advice on your business’s insolvency.
