What is the order of priority when distributing available funds to creditors? The team at Brodies outline IP responsibilities and the implications of the Game Station case.
Formal insolvency is far from a game, but being first, second or third is important when it comes to distribution ranking.
Formal insolvency invariably means that there is not enough money to pay all creditors. When an insolvency practitioner (IP) is appointed, one of their roles is to distribute available funds to the parties entitled to receive them.
The roles of the various categories of IP in this regard differ – for example, a receiver’s ability to distribute funds is significantly different from that of a liquidator, but legislation sets down the ranking of claims that all IPs must follow.
The order of priority hierarchy
The hierarchy by which claims and expenses are paid is known as the order of priority. These apply to both liquidations and administrations. Although there are some differences between English and Scottish insolvency rules, they generally follow the same order.
Assets of the insolvent estate are distributed to meet expenses and debts of the company broadly in the following order:
- secured creditors (treatment of fixed and floating charge holders is different and can vary according to the relevant insolvency regime)
- the expenses of the insolvency process (for example the IP’s fees and outlays)
- preferential debts (mainly employee claims up to the statutory prescribed amounts)
- ordinary unsecured creditors
- interest on preferential and ordinary unsecured debts
- postponed creditors
If there are any funds left after this, then return of capital to shareholders comes into play.
Ordinary unsecured creditors, who get paid (other than by virtue of the prescribed part) only after all prior ranking claims have been paid in full, often have sizeable claims against the company, but are left receiving either no distribution, or a very small one, compared with the size of their claim.
This has led to the order of priority being subject to judicial scrutiny and interpretation. This trend has been reflected in recent English case law (often relied on by the Scottish courts), where the court has been asked to examine whether a claim (previously regarded as an ordinary unsecured one) could rank as an expense of the formal insolvency, and therefore be paid in priority to certain other claims. Of note is the Court of Appeal’s 2014 decision in Jervis v Pillar Denton; re: Game Station (‘Game Station’), the focus of which was on the ranking of landlord claims for rent.
In Game Station, the Court of Appeal clarified matters and said that IPs must operate the ’pay as you go’ approach. If an IP uses rented premises to continue trading, then the landlord’s claim for rent during the period of use requires to be paid as an expense of the insolvency.
There are some limited steps that creditors can take to attempt to elevate their status in the order of priority to ‘expense’ ranking. Whether a claim could rank as an expense will depend on the specific facts and circumstances. The court has, however, in the Game Station decision and other recent decisions, sought to restrict the ability of ordinary unsecured creditors to elevate their claims in the order of priority.
Advice should, however, be sought, lest an opportunity to improve one’s placing is lost.
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