Priority of Funds Distribution In Insolvency
Accounting (Year 12) - Insolvency & CSR
Why is there an Order for Fund Distribution During Insolvency?
Not all creditors are the same. Creditors take different risks and as a result, have a different ranking when a company goes bust and needs to repay its creditors. Some creditors can secure their debt against company property, meaning they can take ownership of the property and hence the proceeds from the sale of the property if the Company goes bust.
Some creditors have no security. The general rule of higher the risk, higher the return, in which less security will demand a higher interest rate.
Priority 1: Liquidator's Fees
Liquidator's fees are paid first otherwise, liquidators would not perform the job without promise of payment. To ensure the highest returns for creditors, the liquidator's fees need to be approved by creditors at creditor meetings.
Liquidators are often specialised Accountants, with the expertise to obtain the highest return from the sale of the assets.
Priority 2: Secured Creditors
Secured creditors are paid first as their debt is secured by the right to sell all or specific business' property if the business cannot repay its debts.
Secured creditors are often banks, who when issuing a bank loan require collateral, business or personal assets that can be sold to repay a loan if the business cannot meet its debts as they fall due.
Priority 3: Employees Wages and Superannuation
Employees are paid a little differently to other creditors. Under new legislation, the Fair Entitlements Guarantee (FEG), a government department under the Attorney General, will pay out unpaid employee entitlements when a business enters liquidation. Funds from the sale of assets during liquidation is then repaid to FEG after all secured creditors have been paid out.
The purpose of FEG is to ensure that employee entitlements are paid out in full and in a timely manner, with FEG rather than the employee incurring the shortfall if there is insufficient funds during a liquidation.
Priority 4: Unsecured Creditors
Unsecured creditors are those who are owed money but have no guarantee over the business property. These can include trade creditors, Government entities, or even customers themselves. For example, when Dick Smith Electronics when into liquidation, customers who held gift cards had to apply to be unsecured creditors.
Choice reported that gift card holders received no return, with the amount on their gift cards deemed worthless.
Priority 5: Shareholders
Shareholders are the last in line in the event of a Company liquidation. They are unlikely to receive anything as if a business is in liquidation, it is likely that liabilities exceeds assets, providing a negative asset and equity position.
Often during liquidations, assets are sold at discount below book value, meaning they are able to realise less than what is on the balance sheet, providing limited returns for shareholders.
What if there isn't money left to pay all creditors at a certain level?
If at a certain level there isn't enough money to pay out all creditors, the amount is then divided up pro rata. In other words, the percentage of the debt you are owed is the amount you receive at a certain level. In the above example, we have three creditors, Tom, Jana and Sarah who are owed $10,000 collectively.
To calculate the amount they will receive, we determine the percentage of the amount owing which is shown in the first table. Tom: 50% (5,000/10,000) Jana: 30% (3,000/10,000) Sarah: 20% (2,000/10,000) After we find out the percentage of the debt they are owed, we multiply this by the amount of money available. In this case it's $4,000.
Hence, they will receive: Tom: $2,000 ($4,000 * 50%) Jana: $1,200 ($4,000 * 30%) Sarah: $800 ($4,000 * 20%)