Who gets paid in a liquidation and in what circumstances is clearly determined in insolvency law. The parties who get paid in a liquidation are paid out of the proceeds of the sale of the assets and collection of any debts due to the company in liquidation. The costs that are incurred in conducting the liquidation and selling the assets, including the costs of the liquidator, are settled from the proceeds of the sale and the collection of debt. These costs are called “costs of administration”.

The creditors are then settled from any monies that remain after the costs have been settled. Only those creditors that submit a proof of claim form that is “proven” (i.e. accepted) in the liquidation will be considered for payment (or more technically, receive a dividend).

All proven creditors are not equal though. There is a strict priority to the order that creditors are paid, depending on who they are and what their relationship was to the company.

One way to think of which creditor gets paid and when they get paid is to think of the creditors in layers. Only if a layer is fully paid will the layer beneath it then get paid. If there is insufficient funds to pay all the creditors that fall within a particular layer then the creditors in that layer get paid on a pro-rata basis and the creditors in the layers beneath it do not get paid. Very simply, the creditors layers are secured creditors, preferred creditors, and concurrent creditors. There are two sub-layers of preferred creditors.

Any creditors that have security against any of the assets of the company are paid from the proceeds of the sale of the secured assets over which they have security. If the secured assets are sold for more than the value of the security then the excess funds go towards those creditors that do not have security (“unsecured creditors” which are the preferred and concurrent creditors). If the secured assets are sold for less than the proven claim of the secured creditor then the secured creditor has an unsecured claim for the balance and becomes a concurrent creditor. Often a secured creditor will have security over most if not all of the assets and so it may be the case that only the secured creditor gets paid.

The unsecured creditors are paid from the proceeds of the sale of the unsecured assets (and any excess funds remaining once the secured creditor has been paid in full). But before the unsecured creditors are paid the costs of administration are settled and only if there are funds remaining will the preferred and concurrent creditors be paid. The first sub-layer of preferred creditors are the employees. They may have claims for any outstanding wages at the time of the liquidation together with their terminal benefits. If the employees are paid in full the next sub-layer of preferred creditor is the revenue service for any income tax due. If these claims are settled in full then payment drops down to the concurrent creditor level and the concurrent creditors, generally trade creditors, are paid on a pro-rata basis.

In the unusual event that all creditors are paid in full then the excess funds are distributed to shareholders.