The money realised from the assets of an insolvent company is applied to meet claims of creditors in a set order of priority. By definition, an insolvent company does not have sufficient assets to pay in full all the liabilities that it owes to its creditors. A primary function of administration and liquidation is to realise the assets of the insolvent company and to distribute the assets among the insolvent company's creditors.
The Insolvency Act 1986 (IA 1986) and the Insolvency Rules 196 (IR 1986) provide a statutory scheme for how an Insolvency practitioner (IP) must apply assets to meet creditor claims. The scheme puts creditors into different classes and the IP applies a descending order of priority. An IP cannot distribute asset realisations to a class of creditors until he has repaid in full the claims of all creditors in the prior ranking class.
Priority of asset distribution in insolvency
The money realised from the assets of an insolvent company is applied to meet the claims of creditors descending order of priority. When one class of creditor has been repaid in full, the remaining assets are applied to the next class (known as a pari passu distribution).
First ranking claims
Holders of fixed charges and creditors with a proprietary interest in assets. A creditor that holds a valid fixed charge over a company's assets is entitled to the proceeds of the realisation of those assets in satisfaction of the liability due to it from the company.
Second ranking claims: expenses of the insolvent estate
The IP pays the expenses of the insolvent estate before paying any other claims. The key point of the priority of expenses include expenses incurred in the course of trading an insolvent company or preserving the assets and can rank ahead of the remuneration of the IP.
Third ranking claims: preferential creditors
After the IP has paid all the expenses of the insolvent estate, he pays the preferential debts from the remaining assets. Preferential debts rank equally in the distribution. Certain claims of some unsecured creditors' debts are given "preferential" status, such as contributions to occupational and state pension schemes; wages and salaries of employees for work done in the four months before the insolvency up to a maximum of £800 per person; holiday pay due to any employee whose contract has been terminated.