The recent Australian Federal Court case of Robinson, in the Matter of ACN 069 895 585 Pty Ltd (formerly known as Waterman Collections Pty Ltd) (in liq) [2013] FCA 706 highlighted the importance of creditors fully participating fully in the liquidation process, rather than sitting on the sidelines and assuming the game is over.
Whether you’re an employee owed wages by a company in liquidation or a supplier seeking payment from an outstanding debtor on the brink of external administration, here’s a quick overview of the rights and obligations of creditors in an insolvency.
Types of creditors
Creditors are divided into two separate categories:
The question of who gets paid first when the debtor company becomes insolvent depends on their priority status as a creditor. The ranking or ‘priority’ of creditors will dictate the dividend in a winding up of the company or payable under a ‘deed of company arrangement’ (in the case of a voluntary administration).
Being aware of the primary differences between these types of creditors can help creditors understand and engage in insolvency processes for their own benefit.
Secured creditors
A secured creditor is someone who has a security interest (as defined in s 12 of the Personal Property Securities Act 2009), such as a mortgage or a charge, over some or all of the company’s assets, to secure a debt owed by the company.
If a company defaults on its obligations under a security interest, a secured creditor can appoint an independent, qualified receiver to take control of and realise some or all of the secured assets to satisfy the secured creditor’s debt. The assets must be sold at market value (or the best reasonably attainable price).
A secured creditor is entitled to:
- Vote at creditors’ meetings for the amount the company owes them that exceeds the amount they’re likely to receive from the realisation of the secured assets
- Participate in any dividend to unsecured creditors on a similar basis
Unsecured creditors
Unsecured creditors rank lower in priority than secured creditors as they have no ‘security’ over company assets. Unsecured creditors may include companies that sold goods or services to the company, such as suppliers and the Australian Taxation Office (ATO).
If a company goes into liquidation, once a creditor has lodged a proof of debt, they’ll need to await the outcome of the liquidator’s investigations. If there are sufficient funds left in the liquidation after payment of the liquidator’s fees and costs, and payment to priority creditors (e.g., employees and secured creditors), the liquidator will distribute any remaining money to unsecured creditors as a dividend payment.
Each category of creditor is paid in full before the next category is paid. If there are insufficient funds to pay a category in full, the available funds are paid on a pro-rata basis (and the following category or categories will be paid nothing).
Unfortunately, there’s no guarantee that creditors will get paid at all. In certain cases, there will be no money (or only a percentage) left in the pool to satisfy creditor claims.
Priority unsecured creditors
What happens when an employee loses their job after their employer company becomes insolvent? Facing unemployment and the unlikely payment of outstanding entitlements is a daunting prospect for those who’ve been cast out after a company enters liquidation.
Employees can, however, take comfort in the fact that they’re a special class of unsecured creditors with priority over other unsecured creditors to obtain employment entitlements. Section 556 of the Corporations Act 2001 (Cth) (Act) lists the priorities for dividends in a liquidation, including employee entitlement priorities.
Generally, employees of the company have a statutory priority of payment with respect to outstanding entitlements (after payment of the costs and expenses of the liquidation, including liquidator fees) such as (in order of priority):
- Wages and superannuation contributions
- Personal injury compensation (if owing)
- Leave entitlements, e.g., annual leave/holiday pay, personal leave (sick pay) and long service leave
- Redundancy payments
The only exception to this rule relates to ’excluded employees’. An excluded employee is someone who in the 12 months prior to the liquidation has been or is a director, spouse of a director or relative of a director.
Excluded employees are subject to a priority cap of $2,000 for unpaid wage and superannuation entitlements and $1,500 for leave entitlements. The balance of entitlements will be treated at the same priority level as ordinary unsecured creditors.
Employees enjoy priority over the floating assets of the company (or those assets secured by ‘circulating security interests’) of secured creditors (s 561 of the Act).
Fair Entitlements Guarantee Act 2012
For employees who lose their jobs when their employer company goes into liquidation, and where the company has exhausted its funds or it will take a long time for the liquidator to realise assets, the Federal Government also offers the Fair Entitlements Guarantee (FEG) legislative scheme (previously the General Employee Entitlements and Redundancy Scheme or GEERS).
This scheme is managed by the Department of Employment (DOE).
Subject to eligibility requirements, the safety net scheme can offer funding relief by payment of leave entitlements, wages, payment in lieu of notice and redundancy entitlements (superannuation isn’t covered by this scheme).
FEG operates in relation to employer liquidations and bankruptcies occurring after 5 December 2012 and GEERS continues to operate in relation to insolvencies prior to 5 December 2012. Under s 560 of the Act, for any money paid out by DOE under the GEERS and FEG schemes, DOE are granted the same priority as employees in the liquidation setting.
Liquidation: creditors’ general rights
Once a company has entered into liquidation, creditors can often feel frustrated, uninformed or ‘out of the loop’. They can feel as if they have little control over the insolvency process and decisions made by the liquidator.
In a liquidation context, creditors should be aware they have the right to:
- Submit a proof debt to the liquidator (with invoices and other supporting evidence to prove the existence of the debt)
- Ask the liquidator questions about the status of the liquidation and inform the liquidator about the creditor’s knowledge of the company’s affairs
- Request that the liquidator call a creditors’ meeting at other times than as specified under the Act, provided they cover the costs
- Vote at creditors’ meetings or appoint special or general proxies to attend and vote on the creditor’s instructions
- Receive written liquidation reports
- Inspect certain books
- Complain to ASIC or the court about the liquidator’s conduct
Dealing with corporate insolvency can be a confusing and complex process. As Insurance Australia Limited (IAL) discovered in the Robinson case, providing valuable information and litigation funding assistance and/or being actively involved can lead to a better result at the end of the external administration process.
Who Gets Paid First When a Company Goes into Liquidation?
When a company goes into liquidation, the most common question is what will happen to the assets of the company and in what order do people get paid.
If you are owed money by company which CRS is handling you will be able to keep up to date with the liquidation process by using our creditor portal. We load all reports we issue to creditors onto our website portal so you can view them at a time which is convenient to you.
CRS can handle all types of company liquidations: 1) Creditors’ Voluntary Liquidation; 2) Members’ Voluntary Liquidation; and
2) Court Appointed.
Updated: 24th January 2021
A preferential creditor is a creditor who is granted preferential status during an insolvent liquidation by receiving the right to first payment, a hierarchy established by the Insolvency Act 1986.
An official ‘hierarchy’ laid down by the Insolvency Act, 1986, determines which group of creditors is paid first during an insolvent liquidation. When a company enters liquidation, each class of creditors must be paid in full (the exception being ‘prescribed part’ secured creditors) before funds are allocated to the next.
Creditors are ranked as follows:
- Secured creditors with a fixed charge
- Administrator/Liquidator fees
- Preferential creditors
- Secondary preferential creditors (expanded to include HMRC for certain taxes)
- Secured creditors with a floating charge
- Unsecured creditors (including all other HMRC debt)
- Shareholders
Secured creditors with a fixed charge
Fixed charge holders are often banks and other asset-based lenders who hold title over a business asset. When a fixed charge is provided to the lender your company loses the right to sell or trade the item. Assets typically covered by a fixed charge include property, plant, machinery, and vehicles.
Assets used in this way are often fundamental to a business, and unlikely to be sold in the normal course of events. Depending on the original agreement, however, in liquidation the asset can be sold by the charge-holder or liquidator to realise funds.
Preferential creditors
Preferential creditors include employees entitled to arrears of wages up to a maximum of £800, and holiday pay.
Secondary preferential creditors
As of 1 December 2020, HMRC moved up the order of priority from unsecured creditors to secondary preferential following new legislation.
Only certain specified HMRC debts are included. These are:
- Value Added Tax (VAT), and debts that relate to the following taxes:
- Pay As You Earn (PAYE) Income Tax
- Employee National Insurance contributions (NICs)
- Student loan repayments
- Construction Industry Scheme deductions
These debts are only preferential if the insolvent business entered a formal insolvency procedure on or after 1 December 2020. For businesses that did enter insolvency on or after that date, the full amount of the specified debts which arose prior to the date of insolvency is payable as a secondary preferential debt.
Secured creditors with a floating charge
Assets subject to a floating charge often include stock, raw materials, work-in-progress, fixtures and fittings – basically any other assets not subject to a fixed charge. Assets of this type can be traded in the normal course of business. Floating charge creditors are entitled to receive a distribution from the net property of the company (the amount remaining after the application of costs) subject to the dilution of the prescribed part.
The ‘prescribed part’ refers to an amount set aside from the sale of floating charge assets net of costs of the liquidation and applies to charges taken out after 15th September 2003. This sum is used to provide unsecured creditors with a greater chance of recovering some of their debt.
Fifty percent of the first £10,000 realised from the sale of floating charge assets is set aside in this way, and then 20% of any further realisations up to £600,000. Terms and conditions relating to fixed and floating charges are laid out in a debenture - a document which is signed by the directors and registered by the lender at Companies House.
Unsecured creditors
These include trade creditors, suppliers, customers, contractors, some staff claims, rent arrears and lease dilapidations, unsecured loans from banks and lenders, unsecured overdrafts, friend and family loans to the business, directors loan accounts that are in credit, and the shortfall on any fixed or floating charge - to name just several examples.
Shareholders
Shareholders are the final group to be paid. Because they have taken a business risk in providing money to the company, they are not entitled to a distribution until all other creditor groups have been paid.
How Begbies Traynor can help
Each class of creditor must be paid in full before the liquidator can distribute funds to the next group. It’s important to maximise the interests of creditors once you enter insolvency, otherwise you may be open to accusations of wrongful or unlawful trading.
Fixed and floating charges are a complex area to understand, particularly if more than one charge has been taken on an asset. Begbies Traynor can clarify your company’s financial position, and identify who takes priority in cases where more than one charge-holder is in place.
We’ll also ensure you meet your legal obligations as a director of an insolvent company, and help to reduce your risk of allegations of misfeasance and wrongful trading.