What’s the Difference Between Secured and Unsecured Creditors?

In short:

The difference between secured and unsecured creditors is that one set have legal claim to an asset if payments default, and the other set doesn’t.
Secured creditors are classified as either having fixed charges in place or a floating charge.
Secured creditors are prioritised over unsecured creditors when it comes to distributing a liquidated company’s assets.

Almost every business will owe money to creditors at some point.  In fact, for most, it’s par for the course when running a company.

Suppliers will often send invoices rather than demanding money upfront, and many owners are dependent on financing and loans provided by lenders.

Normally, all of these debts would be paid off by their respective deadlines in whichever order the owner or finance department deems fit. Problems only start to arise when it comes to liquidation.

As a formal closure method overseen by an insolvency practitioner, liquidation is bound by multiple laws and regulations. One such law relates to the order in which creditors are paid off.

In liquidation, creditors are organised into several different types, with secured creditors receiving priority over unsecured creditors. But what is the difference between secured and unsecured creditors?

What’s the difference between secured and unsecured creditors?

Secured creditors have some sort of ‘security’ as part of their agreement with the business in question. This means that they’ll have a charge over certain assets, much like a mortgage company does with a property if payments aren’t kept up. Unsecured creditors, such as a utility company, have just a promise of repayment, without any legal right to any assets in case of a default.

What is a secured creditor?

A secured creditor is one that required some sort of collateral in return for their funding or services.

Liquidation expert, Ben Westoby explains that “typically, secured creditors will be businesses that have lent the company money in some form or other. These creditors are usually banks and lenders.

“They tend to have the right to some form of asset should the business default on its payments. This can be property, vehicles, equipment or even stock.”

To complicate matters, somewhat, there are two different types of secured creditor: those with fixed charges and those with floating charges. Both have priority over unsecured creditors.

Of the two, secured creditors with fixed charges are given priority in being repaid. In fact, within the order of repayment during a liquidation, they are first on the list.

What is a secured creditor with fixed charges?

These are creditors with a lien over a specific asset. This will generally be a high-value item such as specialist machinery, vehicles, or the company’s premises if owned.

If a director has taken out a loan with a personal guarantee, their family home may also be at risk of repossession.

Westoby adds that “these creditors are given preference over every other type of creditor in a liquidation. They have been promised a specific item should the business default and have a legal right to it.”

What is a secured creditor with floating charges?

These are creditors that also have a right to assets should the company not pay, but these assets aren’t fixed in their value.

For example, they may have a lien over a company’s stock, or even its accounts receivable. Such assets can fluctuate in value over time and are near-impossible to place an exact figure on.

“Although they have a legal right to such assets, there is a chance that the floating charge they have chosen has nothing to offer” warns Westoby. “For example, there may be no money owed to the company, nor any inventory.”

Secured creditors with floating charges come fourth in the creditor repayment order during a liquidation, just one place above unsecured creditors.

What is an unsecured creditor?

Unsecured creditors don’t have a legal right to any assets as security should the business that owes them money not pay up. Instead, they are dependent on the company’s promise to pay them.

Examples of unsecured creditors include landlords, utility companies, suppliers, lenders of unsecured loans and contractors.

In the creditor repayment order, they come fifth out of six in a liquidation, just in front of shareholders.

What is the creditor priority order in liquidation?

Secured creditors with fixed charges
Preferential creditors
Secondary preferential creditors
Secured creditors with floating charges
Unsecured creditors
Shareholders

What is a preferential creditor?

These are usually employees that are due wages or holiday pay.

Secondary preferential creditors, meanwhile, are generally just HMRC in the case of unpaid tax bills.

Liquidations done simply

The liquidation process needn’t be shrouded in smoke and mirrors. At Forbes Burton, we’re committed to making business practices uncomplicated and transparent.

We’ve helped thousands of UK businesses to navigate closures and liquidations. Unlike businesses that only deal in liquidations, we offer a variety of different options from restructuring to selling your business, so we’ll always provide you with the best solution possible for you and your company.

Call us now on 0800 060 8447 for free no-obligation advice. Alternatively, you can get in touch by emailing advice@forbesburton.com.