When a company enters liquidation, the law sets out a strict order for how money is distributed. Some creditors are paid before others, regardless of when the debt arose or how pressing it may feel in practice.
Preferential creditors sit close to the top of this hierarchy. Understanding who they are and how they fit into the wider payment order helps explain why some debts are settled and others are not once liquidation begins.
What does ‘preferential creditor’ mean?
A preferential creditor is a specific type of unsecured creditor given priority by insolvency legislation. Preferential creditors are paid after secured creditors with fixed charges and after the costs of the liquidation, but before floating charge holders and ordinary unsecured creditors.
This status is defined by law. It cannot be agreed contractually and it cannot be changed by directors or creditors. The intention is to protect certain claims that arise from employment, recognising the position employees are in when a business fails.
Who qualifies as a preferential creditor?
In liquidation, preferential creditor status is limited to certain employee-related claims. These include:
- Unpaid wages or salary, capped at £800 per employee
- Accrued but untaken holiday pay
- Specific employer pension contributions
These claims relate to work done before the liquidation date. If an employee is owed more than the statutory limits, the balance becomes an ordinary unsecured claim.
Other employee entitlements, such as redundancy pay and notice pay, are usually claimed from the government rather than the company. In those cases, the state then takes the employee’s place as a creditor in the liquidation.
Where preferential creditors sit in the payment order
Funds realised in liquidation are distributed to creditors in a set order established by insolvency law:
- Fixed-charge secured creditors
- Costs and expenses of the liquidation
- Preferential creditors
- The prescribed part
- Floating-charge secured creditors
- Unsecured creditors
- Shareholders
Preferential creditors must be paid in full before any money is distributed to floating charge holders or unsecured creditors. If there are insufficient funds, preferential creditors share what is available between them and lower-ranking creditors receive no distribution.
How preferential creditors differ from other creditors
It’s common for directors to assume that certain large or influential creditors have preferential status. In most cases, this is not correct.
- Employees are the main preferential creditors
- Banks are typically secured creditors rather than preferential creditors
- HMRC is only a secondary preferential creditor in some cases, such as unpaid VAT and unpaid PAYE.
- HMRC is an unsecured creditor for taxes such as Corporation Tax
- Trade suppliers are also unsecured creditors
This distinction explains why employee claims are often settled ahead of tax liabilities and commercial debts, even where those other balances are significant.
How the prescribed part fits in
The prescribed part is a portion of assets subject to floating charges that is set aside for unsecured creditors. It does not affect the position of preferential creditors.
Preferential creditor claims are dealt with first. Only once they have been settled does the prescribed part calculation apply. Any remaining ring-fenced funds are then available for unsecured creditors.
In many insolvent liquidations, this sequence means that unsecured creditors receive little or no return.
Why preferential creditors matter for directors
Where a company employs staff, preferential creditor claims are a normal and unavoidable feature of liquidation. They must be recognised and dealt with in the correct order.
From a director’s perspective, this has practical implications:
- Employee claims need to be treated consistently
- Company funds should not be redirected away from employee entitlements once insolvency is clear
- Delays can increase wage arrears, affecting the overall creditor position
As financial pressure builds, decisions taken during this period are often reviewed later as part of the liquidation process.
Are directors personally liable for preferential creditor claims?
In most cases, no. Preferential creditor claims remain company liabilities and are handled through the liquidation.
Personal exposure usually arises only in specific circumstances, such as:
- A personal guarantee
- An overdrawn director’s loan account
- Wrongful trading or other forms of misconduct
Where directors have acted responsibly and sought appropriate advice, liquidation allows employee claims to be prioritised in line with the law while maintaining the protection of limited liability.
Key takeaways
- Preferential creditors are mainly employees with limited wage, holiday and pension claims
- They rank above floating charge holders and ordinary unsecured creditors
- HMRC and suppliers are not preferential creditors
- Preferential claims are settled before the prescribed part applies
- Timing and decisions taken before liquidation can affect the overall outcome
Get advice on creditor priority
If your company is under financial pressure and you’re unsure how different creditors would be treated in liquidation, getting clarity early can help you understand your position.
A qualified insolvency practitioner can explain where each creditor sits in the hierarchy, how this applies to your circumstances and what it means for you as a director, before matters escalate or control is lost.
Speaking to someone early often makes the situation easier to understand, even when liquidation is the eventual outcome.
Get in touch with our team of experts for free, no-obligation advice
