Secured vs. unsecured creditors when closing a company

It’s very common to borrow money when running a business to manage operations and growth, whether it’s a business loan, trade credit from a supplier or a regular line of credit. There are also ongoing expenses, including taxes, rent and utilities. These third parties that you owe money to are called your creditors, but not all creditors are the same.

Most companies have a mix of secured and unsecured creditors. If your company is struggling financially, becomes insolvent and you subsequently close it, there’s a significant difference in how those creditors are treated and their likelihood of being repaid in full.

Here we discuss the differences between unsecured and secured creditors, how they are prioritised when a company closes and their repayment prospects.

When closing a solvent company, whether a creditor is secured or unsecured carries far less significance. As the company can afford to pay its debts (it’s solvent), all the creditors can expect to be paid in full as part of the winding up process.

You can close a solvent company via a formal liquidation procedure called a Members’ Voluntary Liquidation (MVL), or an informal process known as Strike Off (also Voluntary Dissolution).

Members’ Voluntary Liquidation (MVL)

In a Members’ Voluntary Liquidation, you must appoint a licensed Insolvency Practitioner to administer the liquidation on your behalf. They will value and sell the company’s assets and use the proceeds to pay all the company’s creditors before distributing the profits among the shareholders.

Strike Off

When striking off a company, it is a legal requirement you pay all the creditors in full before applying to close the business. Any creditors you do not pay can object to your Strike Off application. Companies House will then suspend the process to allow the creditor to seek repayment or take legal action. The Strike Off process will only continue when the matter is resolved.

If your company cannot pay its debts when they are due or its liabilities exceed its assets, it is said to be insolvent. If an insolvent company has no realistic prospect of making a recovery, you must close it. You can do that voluntarily via a Creditors’ Voluntary Liquidation (CVL) or a creditor can force the business into Compulsory Liquidation.

Regardless of the closure method, the outcome is the same. The company will be wound down the creditors will be paid in a strict order. The secured creditors will be able to seize and sell the company assets they hold as collateral to recover their losses. As long as the value of the asset they have security over exceeds the value of their claim, they will be paid in full. If there’s any shortfall, they can try to claim it as an unsecured creditor.

The same is rarely true for the unsecured creditors. By the time the creditors further up the repayment hierarchy have been paid, there’s often little or no money left. Any debts that cannot be recovered as part of the liquidation procedure are then usually written off, and the unsecured creditors suffer the loss.

Creditors’ Voluntary Liquidation (CVL)

A CVL is a company closure process you initiate yourself. You must appoint an Insolvency Practitioner to act as the liquidator. They will sell the company’s assets and invite claims from the creditors. They’ll use the money they raise to repay the creditors according to the statutory order, which means unsecured creditors may be left out of pocket.

Compulsory Liquidation

If a creditor is unable to collect a debt from a company, they can apply to the court to force it into Compulsory Liquidation. In this case, the court will appoint an Official Receiver to liquidate the company. They will then sell its assets and pay the creditors in a defined order.

If your company is insolvent, it’s not advisable to wait for a creditor to force you into Compulsory Liquidation. That’s because it can lead to accusations of wrongful trading and increase the risk of you being made personally liable for the debts the company cannot pay.

When are secured and unsecured creditors paid in liquidation?

One of the fundamental differences between secured and unsecured creditors is the order in which they are paid when an insolvent company enters liquidation.

The repayment hierarchy is as follows:

1. Secured creditors with a fixed charge
2. The liquidator’s costs and expenses
3. Preferential creditors (employee claims for unpaid wages, holiday pay and redundancy entitlements, and certain taxes)
4. Secured creditors with a floating charge
5. Unsecured creditors
6. Shareholders (there’s very rarely anything left)

Crucially, the liquidator must pay every creditor in each class in full before they can move on to the next group. That means, by the time the liquidator reaches the unsecured creditors, there’s often very little to go around.

In the ordinary course of business, unsecured creditors such as suppliers and HMRC cannot pursue company directors for unpaid debts due to the protection they receive from limited liability. However, there are exceptions when closing an insolvency company.

If you…

• sign a personal guarantee
• continue trading when the company is insolvent
• misuse company funds
• sell assets for less than their market value
• or obtain credit fraudulently

… the courts can make you personally liable for some or all of the debts the company cannot pay. You will then have to compensate the company for the benefit of the creditors. You could also be disqualified from acting as a director for up to 15 years and even face criminal prosecution in the most serious cases of fraud.

If you have outstanding debt repayments and are unsure of the best way to close your company or what the impact will be on your creditors, we can help.

At Company Closure, we will discuss your circumstances, explain your closure options and guide you through the process from start to finish. Please get in touch for a free consultation or arrange a meeting at one of our local offices throughout the UK.