Preferential creditor vs secondary preferential creditor
The following article outlines the differences between a Preferential Creditor and a Secondary Preferential Creditor, and how this impacts you if you are categorised as a creditor under one of these classifications.
WHAT IS THE DIFFERENCE BETWEEN A PREFERENTIAL CREDITOR AND A SECONDARY PREFERENTIAL CREDITOR?
Existing Insolvency legislation sets out the payment priorities as regards costs, expenses and creditor payment rankings. Money realised by an Insolvency Practitioner is distributed in accordance with those rankings.
Secured creditors are the highest ranking creditor as they must be paid first from any proceeds from the sale of any assets over which they have security.
The next highest ranking creditor category is preferential creditors, which are split into two tiers, first and second-tier preferential creditors. First-tier preferential creditors are employee arrears of wages, holiday pay and an element of pension scheme arrears.
From 1 December 2020 HMRC were granted secondary preferential creditor status in respect of specific crown liabilities which are as follows:
- Value Added Tax (VAT
- Pay as You Earn (PAYE) Income Tax
- Employee National Insurance Contributions
- Students Loan Repayments
- Construction Industry Scheme deductions
They are referred to as second-tier preferential creditors or secondary preferential creditors.
Collectively the first and second preferential creditors rank after secured creditors but before everybody else. Within the preferential creditors themselves, the first preferential creditors together with statutory interest, if applicable, must be repaid in full before the secondary preferential creditors are paid.
WHAT DOES CREDITOR STATUS MEAN IN RELATION TO COMPANY LIQUIDATION?
A creditor’s status affects where individuals or companies rank for dividend payments. The ranking is as follows:
Secured creditors rank first, specifically over the assets they have security over. Examples of a secured creditor would be a property mortgage, an invoice finance facility or a motor vehicle hire purchase agreement.
Preferential creditors rank second, as set out above.
Next are Floating Charge creditors. These arise when a secured creditor, such as a bank, is still owed money after the assets over which they have security are sold and there are still assets to sell, not subject to their fixed charge security, such as stock. Where the floating charge creditor(s) are going to be paid more than £10,000 the Insolvency Practitioner must set aside a fund known as the “prescribed part” which comes from the money that would be paid to the floating charge creditor. These funds are then paid to the unsecured creditors. This legislation is designed to ensure that where there is significant fixed and floating charge lending, some money will filter through to the unsecured creditors.
Unsecured creditors are next on the list. Broadly this is everybody else. Examples of unsecured creditors would be trade creditors, utilities, rent arrears, employee redundancy and notice pay and unsecured bank lending.
Finally, in the uncommon scenario where all of the above creditors are repaid in full together with any statutory interest, and all costs and expenses of the insolvency have been met, any funds left over will be paid to Shareholders.
WHAT ARE THE DIFFERENT TYPES OF COMPANY CREDITORS?
As stated above, the different types of company creditors are:
- Secured Creditors
- Preferential Creditors
- Floating Charge Creditors
- Unsecured Creditors
- Shareholders
You can see a more in-depth explanation of each type of creditor in the preceding paragraph.
WHO ARE PREFERENTIAL CREDITORS?
As stated above, preferential creditors are HMRC in respect of debts such as VAT or PAYE, employees in respect of wages arrears and unpaid holiday pay and some aspects of pension scheme arrears.
HOW DO YOU BECOME A PREFERENTIAL CREDITOR?
You can’t apply to become a preferential creditor. Preferential creditors are only given this status by legislation.
IS HMRC A PREFERENTIAL OR NON-PREFERENTIAL CREDITOR?
Since 1 December 2020 HMRC rank as a preferential creditor for transactional debts such as VAT, PAYE and Construction Industry Scheme taxation. Other taxation, such as Corporation Tax, remains unsecured.
PREFERENTIAL CREDITORS V FIXED-CHARGE CREDITORS – WHAT’S THE DIFFERENCE?
We’ve defined the difference between these creditors above, but the key difference other than their ranking is that fixed-charge creditors have the power to unilaterally dispose of the assets over which they have security.
Whilst they will often work with an Insolvency Professional as disposal of their assets as part of a larger transaction will usually yield the best returns for everybody, they are within their rights to take control of these assets and sell them themselves. Preferential creditors cannot take control of assets.
ARE EMPLOYEES ALWAYS CLASSED AS PREFERENTIAL CREDITORS?
Any employee (notably not a subcontractor) will rank as a preferential creditor for arrears of wages and holiday pay accrued but not taken. There is a misconception that sub-contractors can claim to be an employee. To be considered an employee, you must have an employment contract. The clearest indicator that you are an employee is that you are on the company’s payroll (PAYE). If not, you are likely an unsecured creditor.
WHO IS NOT INCLUDED AS A PREFERENTIAL CREDITOR?
Unless you are either HMRC, the company’s pension fund, or an employee with a contract of employment, you are not a preferential creditor.
WHAT HAPPENS TO COMPANY ASSETS IN LIQUIDATION?
The Liquidator (usually an Insolvency Practitioner) will attempt to sell the assets of the company to turn them into cash, which can then be repaid to creditors in the priority set out above after the deduction of the IP’s agreed costs and expenses. Read more about liquidation in our Complete Guide to liquidations.
WHAT ARE FLOATING CHARGE CREDITORS?
Floating charge creditors are a type of secured creditor, commonly referred to as a “qualifying floating charge holder” (QFCH. To be a QFCH you will need to have a security document in place and this document must be registered at Companies House within a month of creation for it to be effective in an insolvency procedure.
The charge document will set out which assets are subject to a fixed charge and which assets are subject to a floating charge.
Assuming that the charge document is valid and enforceable, commonly the following assets will be secured on a fixed charge basis.
- Goodwill
- Property – such as trading premises
- Intellectual Property
- Company’s debts (if subject to an appropriate facility)
The floating charge assets are everything else that isn’t caught under the fixed charge security, hence the term “floating”. If your company has a QFCH they may spot any financial distress and ensure you are taking advice and reviewing the position. However, it’s important to consult with an insolvency practitioner (IP) because the QFCH has several rights and powers and any proposed plan to resolve your affairs must be discussed with them to ensure it is agreeable to all parties.
If the QFCH is concerned that matters aren’t being dealt with properly, they can and will exercise their rights to take control of the situation. Any steps they take will primarily be to secure their position as they do not owe a duty of care to the company’s creditors generally.
If you are experiencing financial difficulty, you can be supported through this difficult process by experts who understand the pressures you are facing and have experience in working swiftly to deliver a strategy to resolve the issues you face. This is undertaken by seeking prompt advice from an Insolvency Practitioner
Chamberlain & co offers a free initial one-hour consultation which is discrete and can be held via telephone, face-to-face meeting, or through a digital medium such as Microsoft Teams. All matters are discussed confidentially, and the team is used to making discrete enquiries on a no-name basis when working with you to produce a strategy to resolve your issues.
As with all insolvency practitioners, Chamberlain & Co are committed to delivering best advice in all scenarios, and the team’s work has been recognised regularly at the Yorkshire Accountancy Awards and Turnaround, Rescue and Insolvency Awards.
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