Order of Creditors

[pete_panther]

Hi,

Thanks for your replies in advance.

My company started in last year and was set up to put on an event.

We're technically insolvent, based on the balance sheet showing a minus figure but we're currently approaching investors for funding based on the strength of our business idea.

Currently we technically owe:
a) £10k to the 4 directors, which was originally a personal loan from a family member (i.e. the £10k was loaned to the directors, who then loaned the money to the company);
b) £20k to a family member who loaned us the money with a personal guarantee, i.e. loaned to the company, but if the company is wound up we'll still have to pay them;
c) £15k to a friend who loaned us the money with a personal guarantee;
d) £30k to the bank, loaned with personal guarantees against the directors, but not secured against any assets/personal property;
e) Credit card debts in the directors' names - which I understand would technically be loans from the directors to the company(!?);
f) Money to suppliers related to services provided in advance of payment with personal guarantees, i.e. suppliers who let us use their services with no upfront payment, but following the event we had to pay them, whether or not the company is running or not;
g) Money to suppliers for services provided in advance of payment with no guarantees, e.g. general creditors whose services we used;
h) £8k to directors for unpaid/accrued wages;
i) £2k to HMRC for tax on the above wages.

The company has no fixed assets.

I understand that there are preferential and non-preferential creditors, but not sure how the above would classify. So my first question is, if we had to wind up the company. In which order would each of the above have to be paid off with any cash we do have?

Thanks

 

[Spongebob]

Non of the above are preferential creditors. Time was that the taxman was a preferential creditor and got paid first, but Mr Mandelson changed all that for some reason best known to himself.

All creditors should be treated equally; any monies available should be divided among the creditors in proportion to the amounts they are owed. Everyone should receive the same number of pence in the pound.

Of course this is not what always happens. Most directors in your situation would make sure that the bank was paid off so that the personal guarantees would not be activated. They would also make sure that friends and family were sorted out if possible.

While not strictly lawful, there is every chance that directors acting in this way would get away with it, especially if they successfully applied to Companies House to have the company struck off. No awkward questions would then ever be asked.

 

[pete_panther]

Thanks for your reply.

Therefore is all the money owed to directors themselves also considered to be on an equal 'level' to everyone else? E.g. if we calculated that we could pay 50p to every £1, even the directors would get that same deal and not have to go to the bottom of the list of who gets paid?

Does the money that the directors loaned to the company take any precedence over wages we're owed? Or might they as well be the same thing? e.g. If a director loaned the company £5k and had wages owed of £1k then that director is essentially owed £6k.

 

[internetspaceships]

As Sponge said.

You'll not be getting much back as Directors but with all the personal guarantees you have, you'l be paying a lot out.

 

[Alan R Price]

Hi,

Thanks for your replies in advance.

My company started in last year and was set up to put on an event.

We’re technically insolvent, based on the balance sheet showing a minus figure but we’re currently approaching investors for funding based on the strength of our business idea.

Currently we technically owe:
a) £10k to the 4 directors, which was originally a personal loan from a family member (i.e. the £10k was loaned to the directors, who then loaned the money to the company);
b) £20k to a family member who loaned us the money with a personal guarantee, i.e. loaned to the company, but if the company is wound up we'll still have to pay them;
c) £15k to a friend who loaned us the money with a personal guarantee;
d) £30k to the bank, loaned with personal guarantees against the directors, but not secured against any assets/personal property;
e) Credit card debts in the directors’ names - which I understand would technically be loans from the directors to the company(!?);
f) Money to suppliers related to services provided in advance of payment with personal guarantees, i.e. suppliers who let us use their services with no upfront payment, but following the event we had to pay them, whether or not the company is running or not;
g) Money to suppliers for services provided in advance of payment with no guarantees, e.g. general creditors whose services we used;
h) £8k to directors for unpaid/accrued wages;
i) £2k to HMRC for tax on the above wages.

The company has no fixed assets.

I understand that there are preferential and non-preferential creditors, but not sure how the above would classify. So my first question is, if we had to wind up the company. In which order would each of the above have to be paid off with any cash we do have?

Thanks

To qualify what the guys say above, virtually none of the creditors is preferential. However employees (including directors, if on PAYE) are preferential, for arrears of pay up to £800, and holiday pay.

To improve the balance sheet, you could convert the directors' loans (and possibly the other associated debts) to shares.

 

[pete_panther]

Thanks for your reply Alan.

We're considering coverting debts to shares, but I'm also trying to get my head around the basics.

To clarify, are you saying that technically a person we've loaned money from isn't entitled to their money anymore than the directors are entitled to the money they've loaned the company? The other directors seem to think as a director we'd be last to get any money. (I understand that this would be different if loans were converted to shares.)

I also read that when a company is experiencing financial difficulties that they have to document the reasons why they've paid one company and not another. e.g. If we bought merchandise it'd be ok if we intended on selling it to make more money that'd allow us to pay creditors back.

However, at what point is a company technically considered to be in difficulty? i.e. when are payments just down to the discretion of the company and at what point would we have to start documenting and justifying who we pay? Is it simply when the balance sheet hits £0, or is it not as straight forward as that? (I hope that makes sense.)

Thanks

 

[Alan R Price]

Thanks for your reply Alan.

We're considering coverting debts to shares, but I'm also trying to get my head around the basics.

To clarify, are you saying that technically a person we've loaned money from isn't entitled to their money anymore than the directors are entitled to the money they've loaned the company? The other directors seem to think as a director we'd be last to get any money. (I understand that this would be different if loans were converted to shares.)

I also read that when a company is experiencing financial difficulties that they have to document the reasons why they've paid one company and not another. e.g. If we bought merchandise it'd be ok if we intended on selling it to make more money that'd allow us to pay creditors back.

However, at what point is a company technically considered to be in difficulty? i.e. when are payments just down to the discretion of the company and at what point would we have to start documenting and justifying who we pay? Is it simply when the balance sheet hits £0, or is it not as straight forward as that? (I hope that makes sense.)

Thanks

Nowadays there are, effectively, three classes of creditor: secured (holding a mortgage or charge); preferential (only the employees); and ordinary unsecured. The latter includes suppliers, HMRC, utilities and directors (insofar as they don't fall into one of the other categories). Creditors may agree between themselves to defer their claims - for example banks or other investors may mutually consent to an order of payment different from and supplementary to the statutory one - but in general terms, a director's loan stands on exactly the same footing as an invoice for the supply of, for example, accountancy services.

It is good practice for any company to hold regular board meetings and to record major discussions and decisions in writing. If the company falls into difficulties, the directors' efforts to rectify the situation should be recorded so as to lessen the risk of a claim for wrongful trading by a liquidator if things do go horribly wrong.

A company is insolvent if its debts exceed its assets or if it cannot pay its debts as and when they fall due. Once either of those situations exists for more than a few weeks, the directors must take drastic steps to ensure that the position does not deteriorate. This could involve implementing a rescue plan or in the most severe cases, ceasing trading to avoid incurring any further debts. Once insolvency becomes an issue, deciding which creditors to pay becomes an overriding factor: only payments that are going to benefit creditors overall should be made and no creditor should be preferred. For example directors' salaries may be paid if they are vital to the business and are part of the rescue, but their loans may not be repaid until the position has been rectified. Likewise, essential suppliers may be paid but it is not acceptable to pay off friends and relatives, or certain suppliers as an incentive to them to supply a phoenix company.

It isn't straightforward and my recommendation would be to seek specialist advice in relation to your own situation.

 

[pete_panther]

Thanks Alan. That's cleared up a few things for me.

I'll find someone local to talk to so I can go through things in more detail.

Thanks again.

 

[Alan R Price]

Your accountant may be able to recommend an insolvency practitioner he has dealt with before, or feel free to give me a call for an informal chat if you like. We operate more or less nationally. Our web address is www.marshmanprice.co.uk.

 

[arcon5]

d) £30k to the bank, loaned with personal guarantees against the directors, but not secured against any assets/personal property;

It's worth noting, the debt may not be secured against your property... but if the creditor decided to pursue you personally there is the possibility they put a charge on your house for example.

 

[Alan R Price]

It's worth noting, the debt may not be secured against your property... but if the creditor decided to pursue you personally there is the possibility they put a charge on your house for example.

They can only put a charge on the house if they obtain judgment and then apply for a charging order by way of enforcement; or if the guarantor gives one voluntarily as part of a negotiation for extended payment, for example.

 

[pete_panther]

A few other questions...

1. When we put in the directors' loans we were all a bit rushed and no paperwork was put in place (only a verbal agreement). Does this affect anything? And how can it be rectified?

2. Likewise, some of the money put in came from directors' personal credit cards. Again, are there any issues with this? And how can we make it all official so that all money put in by directors can count either as a loan or be converted to shares?

3. This one seems a little odd to me (but I do come from a sole trader background). One of our creditors was paid straight from my credit card, and when we had the money in the account (when we weren't in the current financial state we're in at the moment) I was repaid that amount by the company. Now one of the other directors is saying that all transactions needed to have gone through the company bank account. So I have to repay that money I was paid back, otherwise it looks like I've been paid a salary (that has to be taxed). Is this correct? I assumed it could be taken care of with paperwork/expenses forms, rather than the physical cash needing to be transferred. Would someone be kind enough to clarify?

Thanks

 

[Scalloway]

You must have invoices that you have paid (or at least copies of them). I would do a list (either in Excel or Word) headed up "Payments by Pete Panther on behalf of X Ltd. Make sure this list matches anything in the accounts and include it with the rest of the company's payments.

I am sure it is quite coomon for ltd companies to have no formal agreement for the director's loan accounts. If cash it is tight it is the only way to keep the business going.

I would advise against converting the loan to shares. What I would do is create a bank account in your accounts called "Directors Loan Account" and use that for payments made by direstors. It would be better to have individual accounts for each director. The directors loan account is a well known method for company directors to provide finance for the company in the early days then withdraw it cash free when funds permit.

There is absolutely no reason for you to refund the payment you made to the creditor. To cover yourself you should take a photocopy of your credit card statement showing the payment to the creditor and put it in the file with the rest of the company payments. You can redact any information you do not wish to share.

 

[rbsmith]

If borrowed amount is secured against personal property then bank may pursue to take over the property in case of non repayment of the amount. If you want to secure your property then you should negotiate with bank for any alternative repayment option. Otherwise, get ready for property repossession.