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 (2nd Edition)
• How do creditors and other stakeholders rank on an insolvency of a debtor? Do any stakeholder enjoy particular priority?
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 overall 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 assets are covered separately as the proceeds from the sale of the charged asset go directly to the secured creditor.
In the bankruptcy of a debtor, the debtor’s assets are required to apply towards payment of bankruptcy expenses and collective debts in the first place, and then towards settlement of other debts in the sequence of employees’ claims, social insurance premiums payable, taxes due, and ordinary claims. Any late-payment penalties arising from unpaid taxes are ordinary claims if the penalties are imposed before the court accepts the bankruptcy application, or they are not considered as bankruptcy claims at all if imposed after the acceptance of the application. Holders of security interests have a priority right to compensation over certain assets. According to the minutes of the meeting of PRC courts on trial of bankruptcy cases, punitive claims, such as civil punitive damages, administrative fines and criminal fines, as well as claims unduly arising between affiliated companies, are subordinate to other ordinary claims.
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 also 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:
(a) claims for a debt owed to a shareholder in that person‘s capacity as a shareholder; and
(b) 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 general principle of a bankruptcy is that all creditors must be treated equally (paritas creditorum); proceeds of the bankruptcy estate will be distributed to the creditors pari passu. This principle does not apply to three groups of creditors: creditors of the bankruptcy estate (e.g. the trustee’s fees, new debts following the bankruptcy date and claims that relate to the performance of existing agreements), creditors with special preferences (e.g. mortgagees and pledgees), and creditors with general preferences (e.g. employees, tax debts, social security debts).
There is no equitable subordination. Few courts have, however, decided to subordinate a creditor’s claim if unlawful conduct by such creditor is established (under the abuse of rights doctrine).
In bankruptcy, the assets of the bankrupt will form the bankruptcy estate, from which the trustee will make distributions to the creditors, pursuant to their statutory ranking. Below is a summary of the ranking of claims in a Dutch bankruptcy.
- Secured creditors: Secured creditors are in principle not affected by a bankruptcy insofar it concerns their recourse on the asset which is secured for their benefit.
- Estate and preferred creditors: Before the ordinary creditors, certain preferred creditors (designated by law) will be paid out of the bankruptcy estate in full (insofar possible). These preferred creditors include the Dutch Tax Authorities, any employees of the relevant entity and the trustee himself for his salary.
- Ordinary creditors: Claims of creditors rank pari passu, except for the estate, preferred and subordinated claims. This means that these ordinary creditors will be paid out of the available funds in the bankruptcy estate (after estate and preferred creditors are paid out), pro rata to the amount of their claim.
- Subordinated creditors: Whether a certain claim is subordinated will have to follow from the relevant agreement from which the claim follows. Subordinated claims will be paid after ordinary claims are fully paid. We do not have equitable subordination in the Netherlands, although there has been recent discussion on this.
- Providers of equity: If all creditors are paid in full and there are remaining funds in the bankruptcy estate, these will be distributed to equity providers of the entity. Clearly, any distribution to equity providers is very rare.
The absolute priority rule under the U.S. Bankruptcy Code requires that creditors are paid before shareholders in accordance with their respective priorities. Thus, secured creditors are entitled to recovery before unsecured creditors, and unsecured creditors are entitled to recover over shareholders. However, the Bankruptcy Code does provide that certain stakeholders with general unsecured claims are entitled to priority payment. Those claims include administrative expenses (including judicial fees and costs), employee wages earned in the 180 days prior to a bankruptcy filing, unpaid contributions to employee benefits plans earned in the 180 days prior to a bankruptcy filing and certain prepetition taxes. The Bankruptcy Code also affords certain claims a “superpriority” status, such as claims for failure to provide adequate protection and claims on account of postpetition financing. Finally, certain provisions of the Bankruptcy Code provide protection for certain creditors such as aircraft financiers, and contain safe harbour provisions to allow derivative contract counterparties to exercise setoff rights and liquidate or terminate contracts after the commencement of the proceeding.
The court may change the treatment of certain creditors’ claims through equitable subordination, recharacterization or substantive consolidation. Equitable subordination subordinates the claim to other similarly situated claims, thus lowering the claim’s priority, if it is shown that the claim holder engaged in wrongful conduct that resulted in harm to other creditors. In the case of recharacterization, the court allows a claim on account of its substance rather than its form (i.e. if claims have attributes that suggest it should be characterized differently). Finally, a court may substantively consolidate an estate, combining the assets and liabilities of more than one debtor, which may eliminate intercompany claims or change relative recoveries or structural priority between the claimants of the various entities.
Insolvency proceedings are concluded with distribution of the company value to the different claimholders in the selected assets of the debtor. The value distribution follows a predetermined rank order. Creditors’ ranking is, however, very complex to describe since it will depend on many factors. However, the priority rules of claims payment are generally the following: (i) employee-related claims (AGS – Association pour la gestion du régime de garantie des créances de salariés) benefit from a preferential status (“superprivilège des salariés”); (ii) costs of the insolvency proceedings; (iii) post-petition claim benefit from a statutory privilege (“new money” priority); (iv) claims secured through security interests over immovable property, specific security interests over movable property, in particular security interests to which a lien (droit de retention) is attached; (v) claims that have arisen after the judgment opening the insolvency proceeding and which are necessary to conduct the proceeding, and all other claims according to existing priority rules.
During liquidation proceedings, claims secured by a mortgage, by a pledge with retention of title or by a registered lien over property, plan or equipment, rank ahead of post-petition claim.
It is generally considered that creditors secured under the Financial Collateral Law and mortgagees are outside of the bankruptcy process, which means that they are not, in principle, subject to ordinary distribution and priority rules.
For all other creditors, the order of priority payments during a bankruptcy proceeding is as follows:
- Creditors of the bankrupt estate (bankruptcy expenses)
- Secured preferred creditors (except as provided above):
- Preferred creditors with a general preferential right
- Legal fees incurred in the creditor’s interest
- Super-preferential employee claims (i.e. employee claims over the last six months of employment; claims related to termination of employment contracts)
- Employees’ contribution to social security
- Tax authority claims
- Employers’ contribution to social security
- Other preferential claims
- Creditors with a non-bankruptcy proof contractual or judicial security
- Lessor’s claims
- Pledgee’s claims (except as provided above)
- Costs of preserving assets
- Unpaid price of equipment used in the debtor’s industrial undertaking
- Other preferential claims
- Preferred creditors with a general preferential right
- Ordinary unsecured creditors
Shareholders are treated as subordinated creditors unless they have other contractual arrangements in place as creditors. Luxembourg law does not recognise the concept of equitable subordination.
Liquidators are able to set aside, or apply to the Court to have set aside, the following transactions:
- Voidable transactions – transactions that were entered into while the company was insolvent, within the two year period before the liquidation application was made, and which allow the creditor to receive more than it would have in the liquidation.
- Voidable charges – charges that were given while the company was insolvent, within the two year period before the liquidation application was made and which did not secure money actually advanced or paid, or the actual price or value of property sold or supplied to the company, or any other valuable consideration given in good faith by the recipient of the charge.
- Transactions at an undervalue – the liquidator may recover from the creditor the difference in value between the value given by the company and the value received by the company as a result of a transaction that occurred while the company was insolvent and within the two years before the liquidation application was made.
- Transactions with directors or other related parties for inadequate or excessive consideration – the liquidator may claim back from a director or related party in relation to the transaction, the amount by which the consideration received by the company was exceeded by the consideration it gave, provided the transaction occurred within the 3 years before the liquidation application was made.
- Securities and charges given by the company to a director or related party if the Court considers that it is just and equitable to set the transactions aside, taking into account the circumstances in which the charge was created, the conduct of the director or related party and any other relevant circumstances. There is no requirement to prove that the company was insolvent at the time the security or charge was given.
- Dispositions that prejudice creditors– dispositions made without receiving reasonably equivalent value in exchange and with the intent of defeating creditors can be reclaimed from a creditor. A six-year limitation period applies from the date the disposition is made.
- Distributions to shareholders that were made at a time when the company failed the solvency test.
A six year limitation period applies from the time when the distribution was made.
A transaction will not be set aside if the third party creditor received the payment in good faith, in circumstances when a reasonable person in the creditor's position would not have suspected and the creditor did not suspect that the company was or would become insolvent, and that the creditor gave value to the company (value can be given before or after the creditor received payment) or changed its position in the reasonably held belief that the transfer was valid and would not be set aside.
A similar good faith defence is available to shareholders who did not know that the company failed to meet the solvency test at the time that a distribution was made.
A liquidator also has the power to disclaim onerous property, which includes unprofitable contracts and property of the company that is unsaleable, or not readily saleable, or that may give rise to a liability to pay money or perform an onerous act. Persons suffering loss as a result of the disclaimer can claim for that loss in the liquidation.
The order of reimbursement of the creditors is strictly provided by the law. Thus, if amounts of money resulted from the sale of an asset that is the object of a mortgage are distributed to the creditors, the payment order is the following: i) the procedure expenses, including the sale fees, the costs that have been paid in advance for the preservation of the asset, the insolvency practitioner’s fee, ii) the secured creditors’ receivables arisen during the insolvency procedure, iii) secured creditors’ receivables. If amounts obtained from the sale of assets that are free of any encumbrances are distributed, the order of payment of the receivables is the following: i) procedure fees and expenses, including the expenses necessary for the preservation and administration of the assets from the debtor’s estate for continuation of business ii) the receivables deriving from financing granted in the insolvency period iii) salary receivables iv) the receivables arisen from the continuation of the debtor’s activity, after the date of opening of the insolvency procedure v) budgetary receivables vi) unsecured receivables vii) subordinated receivables.
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 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.
The priory order between the stakeholder is generally as follows:
- First ranking tax charges – the tax authorities may have first priority charges, mainly with respect to real estate, requiring repayment prior to distribution of the proceeds of a sale.
- Secured creditors and owners of title retention assets – a secured creditor may be able to foreclose its collateral independently from the insolvency proceedings, as set forth in Section 2 above. The same provisions applies in recovery and re-arrangement proceedings to owner of assets under retention of title agreements.
However, a floating charge will be subject to payment to priory creditors, as set forth below.
- Priority creditors – certain debts and creditors will have priority, as follows:
(a) Insolvency proceedings fee and expenses.
(b) Certain amount of unpaid wages to employees or loans granted to the company for the payment of wages up to certain amounts.
(c) Amounts deducted from wages and not paid yet to the income tax assessor.
(d) Certain unpaid local tax and fees to the Registrar of Companies within the 12 months prior to the commencement of insolvency proceedings.
(e) Certain taxes to the state imposed within one year prior to the commencement of insolvency proceedings and one-year rental payments.
- Unsecured creditors – generally all other creditors shall rank equally.
- Shareholders – shareholders may only be entitled by virtue of their shareholdings to the residual value left after repayment of all debt.
Debts to shareholders, not arising by virtue of their shareholdings, shall not be subordinated in the absence of special circumstances justifying such subordination. Such special circumstances exists where if it is found by the court that the shareholders used the company in order to deceive any person or discriminate a creditor, in a way, which is harmful to the company's purpose or by taking unreasonable risk to its ability to repay its debt. In such circumstances, the court may order the subordination of the company's debt to its shareholders to other debts of the company.
Furthermore, under the Securities Law, 1968 ("Securities Law"), a controlling shareholder who holds public bonds of the corporation in distress (as defined therein), will generally not be entitled to receive payment of the liabilities owed to him by the corporation until after the corporation has discharged, in full, its debts to other holders of public bonds, unless the controlling shareholder has held such bonds since they were first issued. Alternatively, if there was a different settlement or arrangement between the creditors of the corporation duly approved in accordance with such provisions.
Under the Israeli court's ruling, the shareholders has very little effect on the approval of a creditor's arrangement, especially when it was not clearly demonstrated that any residual value will remain after repayment of all debts. The new Insolvency Law specifically determines that the shareholders meeting shall only be asked to approve the arrangement if the company's assets allows for the full repayment of all past debts.
In addition, the obligor and its creditor can agree among themselves, usually through inter-creditor agreements, of the order of repayment of debt or ranking of collaterals, and may give public disclosure and possessory protection to such ranking through registration in the appropriate registry.