Charge priority waterfall

The order

Two pots of money, and a queue for each

An insolvency practitioner keeps fixed-charge assets and floating-charge assets apart, because different people have first call on each.

1. Fixed-charge holders are paid from the assets their fixed charge covers (a property, specific plant, sometimes book debts if the charge is drafted tightly enough), net of the cost of selling them. Any surplus drops into the floating-charge pot. Any shortfall becomes a claim further down.
2. Insolvency expenses, including the office-holder's fees, come out of floating-charge assets ahead of preferential creditors and the floating-charge holder, so far as other assets can't cover them (Insolvency Act 1986, s176ZA).
3. Ordinary preferential creditors: mainly employees' unpaid wages for the four months before the insolvency (up to a prescribed limit), accrued holiday pay and certain pension contributions (Schedule 6, paragraphs 8 to 15B). They rank equally and abate proportionately if there isn't enough (s175(1A)).
4. Secondary preferential creditors: for insolvencies where the relevant date is on or after 1 December 2020, HMRC's claims for VAT and for amounts the company deducted but didn't pass on: PAYE income tax, employee National Insurance, student loan deductions and Construction Industry Scheme deductions (Finance Act 2020, s98; SI 2020/983, reg 2). They rank after ordinary preferential debts (s175(1B)). HMRC's other taxes, such as corporation tax and employer's National Insurance, stay unsecured.
5. The prescribed part: what's left at this point is the company's "net property". A slice of it, 50% of the first £10,000 plus 20% of the rest, capped at £800,000 (floating charges created on or after 6 April 2020) or £600,000 (where the first-ranking floating charge is older), is set aside for unsecured creditors (s176A). The prescribed part calculator covers this step on its own.
6. The floating-charge holder takes the net property less the prescribed part, up to what it's owed. It can't share in the prescribed part for its own shortfall unless unsecured creditors have already been paid in full (s176A(2)(b)).
7. Unsecured creditors: trade suppliers, landlords, HMRC's non-preferential taxes, any fixed-charge shortfall not covered by a floating charge. They share the prescribed part plus anything left after the floating charge is paid off. If they're paid in full, any surplus goes to interest on the proved debts (s189) and then to shareholders.

Worked example

£400,000 property against a £900,000 debenture, £600,000 of stock, debtors and cash

One lender holds an all-assets debenture: a fixed charge over the property and a floating charge (created on or after 6 April 2020) over everything else. It's owed £900,000. The property sells for £400,000 net, leaving the lender £500,000 short, which it claims under its floating charge. Stock, debtors and cash realise £600,000 net. Insolvency expenses are £150,000, employees' preferential claims £40,000, HMRC's secondary preferential claim £120,000, and unsecured creditors are owed £800,000.

After expenses and both preferential classes are paid in full, net property is £290,000. The prescribed part is 50% of £10,000 (£5,000) plus 20% of £280,000 (£56,000), so £61,000. The floating-charge holder gets the remaining £229,000 and is still £271,000 short. Unsecured creditors receive only the prescribed part: 7.63p in the pound.

The fixed-charge holder's £500,000 shortfall reappears in rank 6 as part of the floating-charge claim, because the same lender holds both charges. Lender's total recovery: £629,000 of £900,000.

What the model leaves out

Real distributions have wrinkles a single table can't show

Several lenders with fixed charges over the same asset rank between themselves by the rules in charge priority explained, or by whatever an intercreditor agreement says; this tool treats them as one block. Assets not caught by any charge go to expenses, preferential and then unsecured creditors without passing through the floating charge. Where net property is under £10,000, the office-holder can decide not to distribute a prescribed part at all if the cost would be disproportionate (s176A(3)); the tool flags that case but still shows the figure. A floating charge created in the 12 months before the insolvency (two years for a connected person; for an unconnected lender, only if the company was already unable to pay its debts or became so because of the charge) can be invalid under section 245 except to the extent of new money, goods or services given at or after its creation, so some or all of that lender's claim can fall out of rank 6 into the unsecured pile. In an administration the ranking is broadly the same, but it's reached through Schedule B1 rather than the winding-up sections cited here, so check the administrator's proposals for the actual figures.

Why lenders care

This is the arithmetic behind how much a lender will advance

A lender taking a floating charge knows that expenses, both preferential classes and the prescribed part all come out ahead of it. Since HMRC became a secondary preferential creditor in December 2020, a business with large unpaid VAT or PAYE carries a bigger claim in front of the floating charge than it used to. That's one reason a lender's view of what your stock and debtors are worth to them can be lower than what the borrowing base calculator suggests, and why fixed security over specific assets is worth more to a lender than a floating charge over the same value.