Preferential creditor vs unsecured creditor

The following article outlines the differences between a Preferential Creditor and an Unsecured Creditor, and how this impacts you if you are categorised as a creditor under one of these classifications.

WHAT IS THE DIFFERENCE BETWEEN SECURED, PREFERENTIAL AND UNSECURED CREDITORS?

In insolvency proceedings it is set out in legislation the order in which creditors are paid. This order is as follows:

As such, the fundamental difference between creditors is where they rank for dividend payments.

WHAT IS A SECURED CREDITOR?

This is a creditor that has some form of control over your or your company’s assets – this is their “security”. The most common example of secured lending is a mortgage. Secured lending is often broken into two parts referred to as a fixed charge and a floating charge (explained below).

Fixed charge security ranks ahead of all other interests in the assets. For example, if you became bankrupt as an individual or fall into liquidation as a company, the trustee/liquidator would look to sell your or your company’s property to enable the equity to be paid over for the benefit of your creditors.

If there is a fixed charge loan in respect of the property, for example, a mortgage, the mortgage must be paid in full before any amounts are paid over to the insolvency estates. It is possible to have multiple secured creditors over the same asset and they rank based on who has the earliest charge chronologically. The costs of the sale of the assets are usually paid prior to the secured lender, however they will agree the amount of these costs.

Other examples of security are motor vehicle finance, invoice finance facilities, loans (usually large loans), and stock loans. For the security to be valid, the documents need to be properly executed. For example in a corporate situation, all fixed charges need to be registered at Companies House within one month of creation to be valid against a liquidator.

Another example is that the fixed charge holder must demonstrate control over the assets. For instance, they are required to register their property charge at the Land Registry. If you are a secured lender or a borrower and have concerns about the validity of the security, we recommend you seek advice from an insolvency professional.

Finally, in addition to assets which are specifically charged and detailed in the finance agreement, a company’s goodwill, intellectual property and other such assets, are subject to this fixed charge security.

Floating Charge security is commonly owed to a fixed charge creditor who has lent money in exchange for fixed and floating security. This is known as a Qualifying Floating Charge Holder (QFCH). The most obvious example of a QFCH is where you have obtained lending from a company – for example, an invoice lending facility or a business loan – and they have taken a fixed charge over certain assets and a floating charge over all other assets.

Where the creditor has not been repaid in full under their fixed charge security, any amount owing would be repaid under their floating charge. This would be after the repayment of the preferential creditors but before the payment of the unsecured creditors.

However, there is currently legislation referred to as “The Prescribed Part”. In an insolvency where there is to be a floating charge distribution that is over £10,000, a fund is set up called the Prescribed Part.

This is paid to the unsecured creditors from the money that would be due to the floating charge creditors. This legislation was introduced to ensure that where significant distribution was being made under the floating charge, some money flowed down to the unsecured creditors. The Prescribed Part is currently calculated as follows:

50% of the first £10,000
20% of the remaining distribution, to a maximum prescribed part of £800,000

WHAT IS A PREFERENTIAL CREDITOR

We have covered preferential creditors in detail in our article Preferential creditor vs secondary preferential creditor.

EXAMPLES OF SECURED & UNSECURED CREDITORS

As we mentioned above, secured creditors fall into two subcategories:

those with a fixed charge on an asset(s) of the business
those with a floating charge

A fixed charge may be held over a specific asset which was financed by the lender. Business premises, vehicles, or machinery and equipment may have been purchased in this way, with the charge being registered at Companies House, as outlined above.

Another common example is when a factoring company has been used to provide an injection of cash. They lend funds to you as an advance on your sales ledger, which is the asset over which the charge is held.

A floating charge means that in the event of insolvency, the creditor holding the floating charge (as long as it was registered after 15.09.03 in England, Scotland and Wales or 27.03.06 in Northern Ireland) will be placed further down the hierarchy for payment.

Commonly unsecured creditors can fall into one of the following categories:

Contractors
Suppliers
Customers

Broadley, unsecured creditors are any creditor who does not hold security, and is not a preferential creditor.

DO UNSECURED CREDITORS GET PAID?

This is entirely dependent on the specific circumstances of the insolvency.

In an IVA or a CVA, creditors are asked to agree on a proposal and it is for the creditors collectively to approve or reject the offer. If a CVA or IVA is approved, then they should expect to be paid as set out in the IVA / CVA proposal, assuming the client meets their obligations.

Other proceedings are usually used as terminal processes in that the clients’ affairs need resolution and assets need liquidating and whatever funds are raised are paid to creditors.

In the majority of these cases, it is unlikely a dividend will be paid to unsecured creditors. The best way to establish if you are likely to recover money owed is to engage with the appointed Insolvency Practitioner. They are obliged in their formal written reports to indicate to creditors the dividend prospects for each class of creditor, and also to indicate if they consider no dividend will be available, which must be communicated to creditors as early in proceedings as possible.

Often they will know on appointment what the prospects are, although sometimes it may take months or years to conclude, particularly if the client’s affairs are complicated or recovery needs to be pursued through the court.

Administrations are similar to the other forms of insolvency, but in an administration, the administrators must have the belief on appointment that they can rescue the business as a going concern or a better result can be achieved than if the company was liquidated. If neither of those objectives can be achieved, then the administrator must believe that the company can make payment to the secured and/or preferential creditors.

As a result, administrations tend to be used where there are higher value assets or there is some inherent or goodwill value in the business and the prospects of a dividend to an unsecured creditor are slightly better than in a liquidation.

In a Members Voluntary Liquidation, this is a solvent procedure and all creditors must be repaid in full together with statutory interest, if applicable.

WHAT RIGHTS DOES AN UNSECURED CREDITOR HAVE?

The majority of decisions taken within insolvency proceedings, are made by the Insolvency Practitioner (IP) and reported to the creditors.

Creditors have the right to object to any decisions made and may challenge those decisions with the IP in the first instance. If this is unsatisfactory, they may make a court application. Creditors will also be involved in key decisions such as who is appointed as the liquidator (in a liquidation).

In addition, Insolvency Practitioner fees must be agreed upon by the appropriate body of creditors which will often include the unsecured creditors. In an administration, the IP must report to the court every 6 months, and in all other proceedings every 12 months or 8 weeks before the closure of the case, whichever is sooner.

IS A BANK LOAN AN UNSECURED DEBT?

This depends. Most lenders will lend money on an unsecured basis, but once the level of lending reaches a certain amount, they will require security. The exact security should be set out in your loan agreement. Company directors need to consider that one of the main forms of security sought are personal guarantees which can impact a director significantly in insolvency.

If you are unsure as to whether a loan is secured, an Insolvency Practitioner should be able to help.

WHAT IS CONSIDERED AN UNSECURED DEBT?

Examples of unsecured creditors would be trade creditors, utilities, rent arrears, employee redundancy and notice pay and unsecured bank lending.

HOW DO I SETTLE AN UNSECURED DEBT?

Most unsecured lending or borrowing is subject to an agreed rate of repayment. As long as repayment rates are met, then the lending should be repaid. If you are struggling to meet your repayments, either as an individual or a company, we strongly recommend you seek the advice of an insolvency practitioner as soon as possible.

This is because if there is an underlying issue that you need to address in your finances, by planning with an insolvency expert, you may be able to enter into manageable repayment terms or explore options such as debt consolidation loans to deal with financial affairs without the need for an insolvency process.

The longer the matter is left, the more likely you will require an insolvency procedure.

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.

You can contact us by calling 0113 242 0808; or by emailing us at advice@chamberlain-co.co.uk or by completing our online contact form here.