Secured Creditors vs Unsecured Creditors: The Differences

The terms secured creditors and unsecured creditors appear frequently on media and in commercial contexts, so what are the key differences?

Firstly, you are a creditor if a company owes you money. This arises if you have provided goods or services to a company, and that company is yet to pay you. You can also be a creditor if you are an employee that is awaiting payments, such as wages or superannuation. There are two categories of creditors, and depending on your situation, you will be classed as either a secured creditor or an unsecured creditor.

Secured Creditors vs Unsecured Creditors

Whether you are a secured creditor or an unsecured creditor will be crucial particularly when the company by which owes you money faces financial shortfalls or becomes insolvent. When this happens, your status determines the priority you take in being entitled to payments, as well as any rights and obligations you have.

A secured creditor has a security interest in some or all of the company’s assets, for example, through a mortgage or charge. Secured creditors rank higher on the creditor “hierarchy”, and therefore have priority to repossess company assets to cover any outstanding debts.

Conversely, unsecured creditors don’t have a security interest over a company’s assets. They rank after secured creditors, and they do not have a right to repossess company assets to cover outstanding debts.

Employees (except for contractors) are a distinct class of unsecured creditors. In the case of liquidation, their outstanding payments take priority over unsecured creditors.

There are three main situations where it is important to know where you stand as a creditor, and these will be explored below.

1. Voluntary Administration

Voluntary administration is where an independent, qualified person is appointed by the company when the company is insolvent, or is likely to become insolvent in the near future. The voluntary administrator’s main function is to determine if the company’s financial outcomes can be improved. If this is not feasible, the voluntary administrator will recommend the company is placed into liquidation.

Regardless of whether you are a secured creditor or unsecured creditor, you will be able to take part in two meetings, in which you have the following rights:

  • First meeting of creditors:
    • The voluntary administrator must hold this meeting within eight days of being appointed.
    • At least five days’ notice must be given to creditors of this meeting.
    • Creditors can vote to replace the administrator and/or create a committee of inspection (who are appointed from the group of creditors).
  • Second meeting of creditors:
    • The voluntary administrator must hold this meeting within 25 days of being appointed.
    • At least five days’ notice must be given to creditors of this meeting.
    • Creditors can vote on the future of the company. Three possible outcomes can be reached:
      1. Reinstating the directors’ control;
      2. Winding up the company and appointing a liquidator; or
      3. Creating a deed of company arrangement which outlines how debts will be paid.

Importantly, to be eligible to vote at both of these meetings, creditors are required to lodge details of their debts or claims with the voluntary administrator.

 2. Receivership

A right reserved exclusively for secured creditors. When a company is not able to fulfil its financial obligations, a secured creditor will appoint a receiver. A receiver is an independent, qualified person whose primary function is to collect and sell company assets over which it has security in order to satisfy the creditors’ debts. There is a duty on receivers to take reasonable care to sell assets for not less than their market value. Where this is not determinable, the assets must be sold for the best price reasonably obtainable.

Because the receiver is primarily representing to secured creditors, they have no obligation upon them to report to unsecured creditors. Furthermore, unsecured creditors do not have a right to see the receiver’s reports to secured creditors. However, an unsecured creditor can still apply to the court to liquidate, or wind up, a company during a receivership.

 3. Liquidation

Liquidation refers to the situation where an independent, qualified person, known as the liquidator, is appointed to manage the winding up of the company. They do this in a way so as to ensure a fair outcome for all creditors.

This process can be initiated either through a court-ordered liquidation, or through a voluntary liquidation. Both secured and unsecured creditors have the right to initiate the second method.

Creditors have the following responsibilities:

  • To vote at a creditors’ meeting, a ‘proof of debt’ form must be completed and lodged with the liquidator;
  • Approve the liquidators’ fees; and
  • Inform the liquidator about their knowledge of the company affairs

Creditors have the following rights:

  • To vote at a creditors’ meeting once this form is lodged and approved;
  • Oblige the liquidator to recover any unfair preferences, set aside uncommercial transactions and report to the creditors about any other potential claims;
  • To request information, reports and documents from the liquidator;
  • To remove and replace the liquidator;
  • To direct that a meeting of creditors be held;
  • Receive dividends following payments to priority creditors; and
  • Lodge a complaint to the Australian Securities and Investments Commission (ASIC) regarding liquidator misconduct.

The rights and responsibilities of both secured and unsecured creditors overlap significantly in the context of liquidation. An additional right held by secured creditors is to appoint a receiver to collect and sell company secured assets to satisfy outstanding payments. Alternatively, a secured creditor can request the liquidator deal with company assets on their behalf to satisfy debts.

Key Takeaways

  • If you are owed debts by a company, you are a creditor.
  • It is particularly important to know your status if the company is facing financial trouble.
  • Depending on whether you are a secured or unsecured creditor, you will have different rights and obligations.
  • Ensure that you complete and lodge all necessary paperwork to enable you to outline your debts and claims, and to vote at meetings.

 

If you or someone you know wants more information or require advice or help, please don’t hesitate to contact one of our insolvency lawyers on (03) 9600 0162 or email info@lordlaw.com.au.

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