The number of liquidations and sequestrations will, unfortunately, increase due to the COVID-19 pandemic. Preference shareholders with unsecured loans and third party unsecured creditors must be aware of the ranking of unsecured creditors’ claims in the liquidation process. This note specifically focuses on the unsecured loan given by a preference shareholder and not the ranking of dividend payments where a preference shareholder takes preference over an ordinary shareholder. It deals with the ranking of creditors involved in commercial transactions with the insolvent person and not the ranking of costs, wages, tax and statutory debts.
Ranking of creditor claims
The ranking of creditors paid out of the insolvent estate are:
- Payment to creditors with secured claims
- Payment to creditors with unsecured claims
And, in the event of a company liquidation, lastly:
- Payment of the amounts due to the members of the company (shareholders).
Secured versus unsecured creditor claims
A secured creditor holds security for their claim which gives them preference above unsecured creditors.
After payment of the costs, secured creditor claims are at the top of the list of creditors to the value of the security held by them. Unsecured claims (including the unsecured balance of the secured creditor claims) are paid out of the residue available after the secured and preferential claims have been paid, according to s103(1) of the Insolvency Act.
Unsecured preference shareholder loan vs unsecured third party loan
When there are a number of unsecured creditor claims, these are regarded as concurrent claims. Claims must be proved at the creditors’ first or second meeting with the liquidator/trustee and concurrent creditors are paid out in proportion to the amounts each creditor was able to prove.
Proof of a claim could, for instance, be in the form of financial records of the transactions by which money was loaned or invested by the creditor or goods or services were supplied. A minimum of two meetings are held by the liquidator of the insolvent estate. A trustee of the insolvent estate is elected by the presiding officer in the first meeting where creditors also have their first opportunity to prove their claims.
It is the responsibility of creditors with unsecured claims to prove their claim at a creditors’ meeting, either in the first meeting or second meeting, in order to have their claim paid out in proportion to the available residue. The trustee may call for a special meeting if they require more clarity or proof of a certain claim. At the time of investing, taking security is the best option to secure a creditors’ claim and it is advised that such security is taken. Shareholders and unsecured creditors must keep updated financial records of any money loaned to or invested in a company so that in the event of a liquidation, they are able to safeguard investments to some extent. If the security is in the form of third party suretyships or other co-debtor obligations, those rights can be enforced despite the insolvency, to reduce the claim against the insolvent.