How do creditors and other stakeholders rank on an insolvency of a debtor? Do any stakeholders enjoy particular priority (e.g. employees, pension liabilities)? Could the claims of any class of creditor be subordinated (e.g. equitable subordination)?
Restructuring & Insolvency
In bankruptcy proceedings, creditors and shareholders' claims are ranked as follows:
Administrative priority claims (crediti prededucibili): administrative priority claims rank ahead of all other creditors, provided that secured creditors keep the right of preferential satisfaction over the proceeds of sale of their collateral. Administrative priority is, for example, given to claims (i) for fees owed to insolvency practitioners or (ii) that have arisen either from certain pre- or post-commencement DIP financing or following the adjudication in bankruptcy;
Secured claims (crediti privilegiati): creditors with a mortgage, pledge or statutory priority claims (like employees or tax and social security authorities) are secured creditors. Among secured creditors, claims secured by a pledge rank ahead of claims with statutory priority over specific movable assets. Claims with statutory priority over specific real estate assets rank ahead of claims secured by a mortgage. Creditors with statutory priority are paid in the order expressly set out by law according to the nature of their claim. Nothing can be distributed to a lower class unless full satisfaction is obtained by the members of the higher class;
Unsecured claims (crediti chirografari): this category includes claims without security incurred before the debtor's bankruptcy;
Subordinated claims (crediti postergati): repayment of a loan made by a quotaholder to a limited liability company is subordinated to the claims of any other ordinary creditor in the distribution of bankruptcy assets, when, at the time the financing was granted, there was an abnormal disproportion between the borrower's indebtedness and net equity or the borrower's financial situation required an equity contribution rather than a loan. The same equitable subordination rules apply to certain intra-group down-stream and cross-stream loans;
Shareholders' contributions: shareholders' contributions can be reimbursed only when all the creditors of the company have been paid in full.
The Spanish Insolvency Act provides for two main categories of claims: (i) insolvency claims, and (ii) administrative expenses or credits against the estate.
The administrative expenses (“créditos contra la masa”) not included in the liabilities of the insolvency estate, being paid as they become due, are those that (i) generally arise after the declaration of insolvency, (ii) and are mainly originated to facilitate the insolvency procedure.
Insolvency claims, as claims filed before the declaration of insolvency, are divided into privileged (general and special), ordinary and subordinated (both unsecured credits).
Privileged credits can have a special or general privilege, depending on whether the security is created over a specific asset (special privilege) or over all of the debtor’s assets (general privilege).
Credits with special privilege generally include those in which collateral consists of specific property or rights (mortgage or pledge) or equivalent rights (financial lease agreement for the leased property). The privilege will only cover the part of the claim not exceeding the value of the respective guarantee.
Credits with general privilege include (i) credits relating to salaries (subject to the legal limits of triple the minimum inter-professional salary) and indemnity for termination of agreements, occupational health and safety claims, provided they are incurred prior to the insolvency; (ii) tax and social security withholdings; (iii) credits for individual work by independent contractors and those corresponding to authors for the assignment of licensing rights over intellectual property works, accrued during the six months prior to the declaration of insolvency; (iv) tax credits, other credits of public entities and Social Security credits up to a maximum of 50% of their value; (v) credits arising from tort liability; and (vi) finally, 50% of the credits held by the creditor at whose request has been declared the insolvency.
Finally, creditors’ claims can also be considered as subordinated (those which are legally relegated to a position below ordinary credits) in the following cases: (i) notice of the credit is given late, (ii) contractual covenant, (iii) its ancillary nature (e.g. surcharges and interest, except those having an in rem guarantee), (iv) penalty (fines), or (v) the credit holder’s personal status (parties specially related to the debtor, or parties that have executed bad faith actions that are detrimental to the insolvency proceedings or that obstruct performance of the agreement to the detriment of the insolvency).
Insolvency Act also foresees that creditors entering into a refinancing agreement shall not be affected by equitable subordination for being considered as: (i) de facto directors, when said creditors have undertaken certain obligations in connection with the viability plan ; nor (ii) as specially related persons for purposes of equitable subordination, when said creditors have become shareholders of the debtors as a result of a debt-for-equity swap implemented in the context of a statutory refinancing agreement.
In bankruptcy proceedings, creditors’ claims are ranked in the following order:
- estate claims (e.g. fees for trustees, administrative expenses, tax claims which became due within one year before the commencements of bankruptcy proceedings, employee compensation for their work within three months before the commencements of bankruptcy proceedings);
- superior bankruptcy claims (e.g. tax claims and employee compensation which are not estate claims);
- ordinary bankruptcy claims; and
- subordinated bankruptcy claims (e.g. interests after the commencement of bankruptcy proceedings).
In special liquidation proceedings, creditors’ claims are ranked in two categories. Claims in the first category basically correspond to estate claims and superior claims in bankruptcy proceedings. Claims in the second category basically correspond to ordinary bankruptcy claims and subordinated bankruptcy claims in bankruptcy proceedings. The first category is superior to the second category.
The priority of shareholders is the lowest both in bankruptcy proceedings and special liquidation proceedings. Japanese law does not have a rule of equitable subordination.
The order of priority of the creditors is governed by the Danish Insolvency Act.
According to the order of priority, costs and fees related to the administration of the estate are covered first.
Next costs related to a vain restructuring attempt or vain attempts at an over-all arrangement with the debtor’s creditors prior to the insolvency are covered.
Employees’ claims are covered next.
Next claims are covered that concern duty on goods that are subject to duty, eg alcoholic and tobacco goods.
Next, the unsecured creditors are covered, eg an ordinary receivable based on an invoice, tax and VAT claims etc.
Finally, claims for interest after the issue of the insolvency order, gifts and fines are covered.
Creditors that hold a charge or another type of security over the debtor’s as-sets are covered separately as the proceeds from the sale of the charged asset go directly to the secured creditor.
When a company is wound up, the statutory distribution waterfall in Australia generally provides that secured creditors are paid first in priority to unsecured creditors. There is an exception to this for employee entitlement claims. During a receivership, winding up (or under a deed of company arrangement), the entitlements of employees have priority over the proceeds available from a realisation of assets subject to a circulating security interest (formerly a floating charge).
The remuneration, costs and expenses of insolvency practitioners appointed will be afforded priority over all creditors’ claims, including employees.
There is no concept of equitable subordination under Australian law and shareholder loans generally rank equally with unsecured claims. The only shareholder claims that are subordinated to unsecured claims are:
- claims for a debt owed to a shareholder in that person‘s capacity as a shareholder; and
- claims arising from the buying, holding, selling or other dealing in shares of the company.
Otherwise, the relationship between creditor groups is very much a feature of contract and Australian courts will generally give effect to whatever contractual arrangement and/or structural subordination arrangements a company and its creditors have agreed to, even where doing so leaves whole creditor groups out of the money.
The legal rights of secured creditors are unaffected by the liquidation of a company and will be permitted to enforce their security by, for example, selling any charged asset in order to secure repayment of the sum owed. However, whilst secured creditors rarely participate in the liquidation process, in the event that the sale proceeds realised for a charged asset are insufficient to discharge the outstanding debt, a secured creditor may rank as an unsecured creditor in the liquidation for the balance of the debt.
Cayman law provides for a very limited class of preferential creditors. Such preferred debts include wages accrued during the four months immediately preceding the commencement of the liquidation, payments due in respect of any medical health insurance premium and any taxes due to the Cayman Islands Government. Under the Companies Law, preferred creditors rank ahead of both unsecured and secured creditors, where the secured creditor's security is in the form of a floating charge but behind the liquidation expenses (including the liquidator's remuneration and legal expenses).
The general body of unsecured creditors will rank pari passu in respect of their claims in the liquidation and the quantum of any distribution made to such creditors will be determined by the value of any realisations achieved by a liquidator in the liquidation.
Rights of set off and subordination are recognised under Cayman Islands law, although a creditor which extended credit to a company at a time when it had notice of a winding-up petition cannot offset such a debt against the debtor company. Netting agreements relating to financial contracts (including multilateral netting) will prevail over the statutory set-off provisions.
Secured claims are satisfied directly out of the net proceeds from the realisation of the collateral. Should the proceeds not be sufficient to satisfy the claim of the secured creditor, the remainder of the claim ranks as an unsecured and non-privileged claim.
Unsecured claims are divided into three classes. Insofar as corporate debtors are concerned, the first class consists of certain employee claims up to a maximum amount of currently CHF 148,200 per employee as well as certain pension related social security claims, the second class includes claims of various contributions to social insurances and all other claims are comprised in the third class. Claims in a lower ranking class will only receive dividend payments once all claims in a higher ranking class have been satisfied in full and claims within a class are treated on a pari passu basis.
Subordination may result from a contractual subordination or an equitable subordination:
- Contractual subordination comes in two forms, i.e. (i) in the form of a deep subordination within the meaning of Art. 725 para. 2 of the Swiss Code of Obligations (CO) where the creditor has agreed to come 'last in row' and (ii) in the form of a bilateral subordination (Nachrang) which only benefits selected creditors. The treatment of the former category is well established under Swiss law whereas the treatment of the latter category is disputed in an insolvency context.
- The concept of equitable subordination is being discussed primarily for shareholder and certain other affiliated parties' loans where funds were made available to a corporate debtor in a financial distress situation where no other third party financing would have been available. If admitted, an equitable subordinated claim would be treated in the same way as a claim subject to deep subordination.
It is generally distinguished between the
- costs of the proceedings,
- other liabilities of the estate (sonstige Masseverbindlichkeiten), ie any liabilities incurred by the (preliminary) insolvency administrator in the administration of the estate and
- general or secured insolvency claims.
General insolvency claims are those existing prior to the opening of the insolvency proceedings. They receive a dividend of the proceeds from the realisation of the estate’s assets after all costs of the proceedings and all liabilities of the estate have been fully satisfied.
Secured claims are general insolvency claims, but the security interest will entitle the creditor to separate satisfaction from the proceeds of the realisation of the collateral. To the extent that the secured claim is not satisfied in full by the realisation of the collateral, the secured creditor is entitled to a dividend pari passu with the other general (unsecured) insolvency claims in respect of the balance.
Certain claims are subordinated by law (Sec. 39 Insolvency Code), including:
- interest accrued after insolvency proceedings have been opened;
- costs incurred in asserting claims in the insolvency proceedings;
- fines and penalties in criminal and administrative proceedings;
- claims to gifts promised by the debtor; and
- shareholder loans.
With the exception of loans granted under an insolvency plan, super priority and preferred claims are foreign to German insolvency law. Claims of employees are general insolvency claims.
The proceeds obtained from the liquidation of the assets of the insolvent entity will be applied to make payments to creditors in the following order of priority:
First, labor claims for salaries and severance for the calendar year immediately preceding the insolvency judgment (the “Insolvency Judgement”).
Second, claims derived from financing incurred for the management of the estate of the insolvent entity or financing that is indispensable to maintain the ordinary operations of the company and the necessary liquidity during the insolvency proceeding (“DIP Financing”), in each case, as approved by the Mediator or by the Insolvency Court.
Third, liabilities and obligations of the estate of the insolvent entity (i.e. management costs, fees and expenses incurred after the Insolvency Judgment is issued).
Fourth, costs and expenses derived from judicial and extrajudicial proceedings for the benefit of the insolvency estate.
Fifth, amounts paid to secured creditors as described below.
Sixth, labor claims (different than those described in first paragraph) and tax claims.
Seventh, claims of creditors that qualify as “privileged” under Mexican commercial laws (e.g. creditors that are entitled to retain an asset until payment is made), but only to the extent of the value of the respective privilege.
Eighth, claims of unsecured creditors.
Ninth, claims of (a) subordinated creditors, and (b) creditors that are related parties of the insolvent entity (“Subordinated Creditors”).
Notwithstanding the foregoing, claims of secured creditors would be paid on a “super-priority” basis up to the amount of the respective collateral, and only the following claims would have priority over the amount of such collateral:
First, labor claims for salaries and severance for the calendar year preceding the issuance of the Insolvency Judgment.
Second, litigation expenses related for the defense or recovery of secured assets.
Third, necessary expenses for the repair, maintenance and disposition of the secured assets.
British Virgin Islands
In general, the following priorities apply:
- Set-off: An unsecured creditor may be able to take advantage of statutory set-off provisions where there is mutuality between credits and/or debts to the extent that there are any funds of the debtor’s in its hands. In addition, netting agreements continue to be enforceable, save in cases of fraud or misrepresentation.
- Secured creditors: secured creditors can enforce against their collateral notwithstanding the supervening liquidation, and may also add interest to their security, subject to the note at 3 below.
- The costs and expenses of the liquidation: this includes the liquidator’s remuneration (sanctioned, if necessary). If the assets of the company that are not subject to any security interest are insufficient to pay the liquidator’s costs and expenses and the preferential claims, those claims take priority over any floating charge and will be paid out of the assets subject to the floating charge. Any remaining assets may be applied towards satisfying the floating-charge-holder’s claim: section 208 IA.
- Preferential creditors: this class comprises—
i) the wages and salary of present and past employees in respect of the period of six months immediately before the commencement of liquidation up to US $10,000;
ii) accrued holiday pay in respect of the period before the commencement of liquidation up to US $10,000;
iii) any amount due by the debtor to the BVI Social Security Board in respect of employees’ contributions deducted from the employee and in respect of employers’ contributions payable for six months immediately before the commencement of the liquidation;
iv) any amount due in respect of pension contributions or medical-insurance contributions payable in the period of twelve months immediately before the commencement of the liquidation, including amounts deducted from employees, up to the amount of US $5,000 per employee;
v) sums due to the government of the Virgin Islands in respect of any tax, duty (including stamp duty), licence fee, or permit, up to the total amount of US $50,000; and
vi) sums due to the Financial Services Commission in respect of any fee or penalty up to the total amount of US $20,000.
Preferential claims rank equally between themselves, and if the assets of the company are insufficient to pay them all in full, they are paid rateably.
- All other unsecured creditors’ claims.
- Subordinated claims: a creditor may acknowledge or agree that in the event of a shortfall of assets he will accept a lower priority in respect of a debt than that which he would otherwise have under the IA, that acknowledgment or agreement takes effect.
- Post-commencement interest: any creditor in a liquidation is entitled to claim interest on its debt in respect of the period after the commencement of the liquidation. Payment of post-commencement interest will be made out of any surplus that remains after all claims in the liquidation have been paid in full before being applied for any other purpose.
- Members: Any surplus remaining after paying the costs and expenses of liquidation and the claims and interest must be distributed among the members of the company in accordance with their rights under the company’s memorandum and articles of association. If the company has preferential shares and ordinary shares, distribution among members will reflect this.