Who gets paid first when a company goes into administration or liquidation?

When a business goes into administration or liquidation, any money that is available from assets of the firm is used to meet debts owed to creditors. The debts are set into a list of priorities and each is paid according to their ranking. Because an insolvent company is in that position because it is unable to pay its debts in full, some creditors will not receive the full amount owed to them, if anything at all. However, the administration or liquidation of a business occurs in order for any assets to be realised and used for at least part payment of the liabilities and debts.

The Insolvency Act 1986 along with the Insolvency Rules 1986 (and 2016) set out the legislation relating to how the Insolvency practitioner must act in order to apply assets and available funds to meet claims from the firm's creditors. Through the scheme, each creditor is assigned into different classes, and the Insolvency Practitioner will assign an order of priority. No assets can be applied to creditors until the classes and priorities have been set and priority claimants must receive their payments prior to anyone below them in the ranking.

What does it mean when a company goes into administration?

If a company goes into administration, they enter into a legal process that sets out to achieve one of the statutory objectives. This could mean that a viable business is rescued or might mean that it goes into liquidation and ceases operating.

When a business goes into administration, an administrator is appointed who is a licenced practitioner in insolvency. The administrator's job is to manage the process, including putting a hold on any creditor enforcement action and establishing repayment options to those that the company owes money to.

How is asset distribution priority set in an insolvency?

When a firm goes into administration, debts are paid to creditors through assets of the business in a descending order of priority. When the creditor who takes top priority is repaid fully, the next creditor claim is addressed and so on until the assets are no longer available. This process is referred to as a pari passu distribution. The ways in which priorities are set are as follows:

The top ranking priority claimant will be those who have a proprietary interest in the business's assets and those creditors who hold fixed charges. Holders of a valid fixed charge over the firm's assets are entitled to receive the proceeds of assets to the value of the liability which is due to them from the business.

The second ranking claimants are those who are owed expenses of the insolvent business' estate. The Insolvency Practitioner is required to pay expenses from the insolvent estate prior to making payment against any other claims.

Third ranking claims are those which are made by what is recognised as preferential creditors. Once payments have been made against the expenses of the insolvent business' estate, the Insolvency Practitioner will pay the preferential debts from any assets that remain. Preferential debts are equally ranked in distribution although some unsecured debts will be given a further preferential standing. This will include debts such as payments towards state and occupational pension plans, staff wages and salaries for any work that employees had completed in the four months prior to the insolvency and up to a maximum of £800 per staff member. Holiday pay for any staff whose contract was terminated as part of the insolvency may also be paid if possible.

Fourth ranking claims are given to those who hold floating charges. Once all of the claims against the insolvent estate and the preferential debts have been settled, the Insolvency Practitioner may use any remaining assets to cover any floating charges. These are charges that will automatically cease on the date of the insolvency and they convert from being a generic charge over a set of assets to a fixed charge for specific assets with a set class.

Fifth ranking claims are those given to unsecured creditors. The Insolvency Practitioner will only pay unsecured creditors once all other debts have been paid if assets are available. Unsecured creditors will have no security over any of the assets of the insolvent company, and so their repayment priority is low. In order for an unsecured creditor to be paid, they must prove that the insolvent firm had a debt to them.

Shareholders will rank in sixth place for debt repayment priority in an insolvency case. Any funds that remain once all of the above creditors have been paid will be split between shareholders.

Are the directors obliged to act in a certain way when a company goes bust?

Once a company becomes insolvent or goes into administration, the directors have legal obligations and moral expectations. This includes a duty of care to ensure that they act to enhance the creditor’s interest as much as possible. Put simply, this means that directors must try to maximise the return to creditors by acting in their best interest. They do this through thoroughly assessing the situation, gathering as much relevant information as possible, setting clear objectives and making their decisions with the priority of protecting creditors at every opportunity.