Businesses will know all about their trade creditors. They're the ones you owe money to on a day-to-day basis to keep the business functioning.
But there are different types or classes of creditor, with varying rights in given situations.
This is a brief summary on the topic to provide some additional guidance.
NB: It is not yet known what type of creditors the lenders will be under the Government's Coronavirus Support package announced on 17th March 2020, so this is an area to watch out for when the details are announced.
Ordinary or Unsecured Creditors
These are the people and businesses who are owed money in the ordinary day-to-day running of a business: e.g. suppliers of goods and services, rent, rates, utilities etc.
They have no special rights against the business or company beyond what is written in their contracts and terms and conditions of supply. In other words, if more than one of these creditors was chasing for payment, they would not be able to get ahead of the queue and beat the others to getting paid first.
Interestingly, HMRC is an unsecured creditor for all forms of tax under the Enterprise Act of 2002.
BUT under legislation expected to be introduced in the Finance Act 2020, HMRC will regain its status as a preferential creditor for insolvencies that commence on or after 6 April 2020. This means that in an administration or liquidation, HMRC will now move up the rankings of who gets paid out first, jumping ahead of floating charge and unsecured creditors.
Secured Creditors
These are creditors who have taken some form of security or collateral (if your want a more American term for it) in return for making some form of credit or loans available to the business.
The security (and it can take many different forms) means that if the business defaults by not paying (capital and/or interest) on time or, perhaps more usually, not all, then the creditor can use the security to get repaid.
That happens by the creditor taking the necessary steps to sell or liquidate the security that is being held and/or through the appointment of a Receiver, if that right exists in the security documentation.
Secured creditors can therefore get paid ahead of ordinary or unsecured creditors through exercising their rights over the security they hold. A fixed or floating charge created by a company must be registered at Companies House (see below).
On an insolvency of a company, there is a fixed priority of creditors who get paid- see below.
Preferred Creditors
A preferred creditor is, as the name implies, one whose right to payment is treated under law as being in priority to others.
When a company can’t afford any longer to pay its bills, certain payments are prioritised over others based on criteria outlined in the Bankruptcy and Insolvency Act 1986.
Preferential debts are paid after fixed charges and the expenses of the insolvency, but before the holders of floating charges and unsecured creditors. The current categories of preferential debt are defined by Section 386 and Schedule 6 of the Insolvency Act 1986.
The types of creditor who are treated as preferred primarily consist of employees for arrears of wages, accrued holiday pay, unpaid contributions to occupational pension schemes and state scheme premiums, all within certain limits. HMRC is also set to become re-instated as preferred creditor (see above).
Types of Security
Fixed charges:
A fixed charge is a charge or mortgage secured on particular property, e.g. land and buildings, a ship, piece of machinery, shares, intellectual property such as copyrights, patents, trade marks, etc. It needs to be registered at Companies House to be effective as a priority against other creditors.
A fixed charge means that the borrower cannot sell or otherwise dispose of the asset that is subject to the charge without the consent of the lender with the benefit of the charge.
If there is the borrower defaults under the loan agreement (e.g. non-payment of capital or interest) the lender can step in an exercise its rights against the charged assets, which usually involves its sale either by private treaty or at auction.
It’s important to note that a fixed charge repayment ranks before that of a floating charge repayment in a company's insolvency.
Floating charges:
A floating charge is a type of security that's exists only for companies.
It's a charge created by agreement between the lender and the company on (usually) all of the company's assets, both present and future, such that the company may continue to use and deal with those assets in the ordinary course of its business. Very occasionally the charge is over just a class of the company's assets, such as its stock.
A company that has created a floating charge can therefore continue to trade with its assets that are subject to the charge and also to sell and replace plant and machinery, etc. without the need to get consent from the lender.
The charge is said to 'float' over the charged assets, rather than being specifically fixed on them (as in a fixed charge).
This 'floating' status continues until something happens for the charge to 'crystallise', under the express terms of the loan and security document. This usually includes a failure to pay interest and/or capital when required, or if the company goes into liquidation or ceases to trade.
Debentures:
This is the document that sets out the fixed and floating charges and the attached terms and conditions.
It sets out the amount of the loan, interest payable on the loan, when the loan is to be repaid, creates any charges to secure the loan and insurance, etc.
Debentures must be registered at Companies House in order to create a valid floating charge.
The lender will send the debenture document to be recorded on the borrower's file at Companies House, which a public register pen to inspection. once the company has signed it.
Registration will prevent other people taking security against the same assets, unless a Deed of Priority is created, which permits this to happen and to regulate the competing interests of the secured creditors.
A debenture provides security for the lender or bank, should the company fall into insolvency.
What type of Security do the banks usually take?:
Most companies who take loans from retail banks (i.e. the high street variety), will end up giving as security what is called an "All-monies debenture" .
This type of document is one that gives the lending bank a fixed charge on any of the company's assets that the bank decides it is worth having as security (often this is real property or machinery) plus a floating charge on all its other assets.
This is regarded as the best form of security from the bank's perspective, while giving the company some flexibility to continue to use and trade with the assets that are subject to the floating charge.
Don't forget that banks may also require additional security in the form of personal guarantees from from the and/or shareholders (see below).
Personal Guarantees
A personal guarantee in the business context is an agreement under which a business owner or company director (guarantor) assumes some degree of personal responsibility for the debts and obligations of the business or company.
The guarantee is there to provide security, usually as back up to a fixed and/or floating charge (see above), for loans or credit given by a bank or financial institution. It is a powerful lender's tool because it impacts directly on the individuals involved in the business.
The effect of giving a personal guarantee is that if the business or company defaults on its loan or credit terms, the lender can require the guarantor to pay instead.
One of the lesser understood potential effects of personal guarantees is that they can result in the guarantor having to liquidate some or all of his or her own savings and even, in extreme cases, to sell their home.
For this reason, personal guarantees are usually the last resort for anyone to enter into. But, for some, it becomes unavoidable if the bank insists on one as a pre-condition to lending to the business.
Here are some things to consider before offering to give a personal guarantee- RealBusinessRescue
By the publications team at: Contracts-Direct.com
Publisher: Atkins-Shield Ltd: Company No. 11638521
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Note: This publication does not necessarily deal with every important topic nor cover every aspect of the topics with which it deals. It is not designed to provide legal or other advice. The information contained in this document is intended to be for informational purposes and general interest only.
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