Order of satisfying creditors’ claims during bankruptcy of legal entities: key nuances

According to statistics, in most cases during bankruptcy proceedings, a decision is made to liquidate the debtor – in such cases, their property and other assets are sold, and the proceeds are distributed among creditors to satisfy their claims. However, as practice shows, the debtor usually does not have enough money to repay all debts to creditors.

The law, therefore, establishes a clear order of priority for the satisfaction of creditors’ claims. This ensures that the most important obligations, such as the payment of wages to employees, court fees and so on, are settled first, whilst those of lower priority are settled only if there are any remaining funds.

According to the Code, proceeds from the sale of the debtor’s property and other assets are used to settle obligations in a specific order of priority. There are six priority classes for satisfying creditors’ claims. Claims in each class are satisfied only after claims in the preceding class are fully settled. If the debtor’s assets are insufficient to fully satisfy all claims in a particular priority, the funds are distributed among the creditors in that priority on a pro rata basis.

Below, we will examine in detail all the priority levels for satisfying creditors’ claims, the associated nuances, as well as valuable advice that will certainly prove useful to creditors.

First priority for the satisfaction of creditors’ claims

The following claims fall under the first priority:

• Payments to gig specialists under gig contracts. This includes claims for payment of arrears for work performed and/or services provided, as well as other funds owed to gig specialists under gig contracts concluded in accordance with the Law of Ukraine ‘On Stimulating the Development of the Digital Economy in Ukraine’, and insurance contributions calculated on these amounts for compulsory state pension insurance and other social insurance, including repayment of loans obtained for these purposes;

• Wages to employees. All outstanding wage arrears (including those relating to dismissed employees), compensation for unused leave, severance pay, guaranteed and social benefits, as well as the corresponding insurance contributions;

• Compensation for losses to the state. Claims for compensation for losses caused to the State Budget of Ukraine in connection with the enforcement of judgments of the European Court of Human Rights against Ukraine;

• Claims under insurance contracts;

• Costs associated with the bankruptcy proceedings (payment of court fees, advance payment of the insolvency practitioner’s remuneration);

• Audit costs. If the audit was conducted by order of the commercial court and paid for by the creditors, these costs are also to be satisfied in the first priority; 

• Claims under interim or new financing agreements in the preventive restructuring procedure. 

Thus, the essence of the first priority is to protect the employment rights of company employees and gig workers, to safeguard the interests of the state, and to cover the costs of the bankruptcy proceedings.  

Second priority for the satisfaction of creditors’ claims 

In accordance with the provisions of the CUBP, claims of a particularly social nature, aimed at protecting the rights of individuals who have suffered harm or whose funds have been placed under trust management by the debtor, are satisfied in the second priority. 

Consequently, the second priority includes claims relating to compensation for harm to life/health and social security contributions. These include: 

• Claims for compensation for harm to the life and health of citizens through the capitalisation of relevant payments in the liquidation proceedings;

• Claims for the payment of insurance contributions to the compulsory state pension scheme and other social insurance schemes; 

• Claims by citizens – settlors (depositors) of trust companies or other business entities that have attracted the property (funds) of settlors (depositors).

Third priority for the satisfaction of creditors’ claims 

In accordance with the CUBP, claims relating to the debtor’s public-law obligations to the state are satisfied in the third priority. These include: 

• Claims for the payment of taxes and duties (mandatory payments); 

• Claims of the central executive authority responsible for managing the state reserve. 

The third priority reflects the primacy of the state’s public interests in the bankruptcy proceedings, ensuring the repayment of mandatory payments to the budget after the socially significant claims of the preceding priorities have been satisfied.

Fourth priority for the satisfaction of creditors’ claims 

Claims of creditors not secured by a pledge are satisfied in the fourth priority. These include all creditor claims arising from legal relationships that do not provide for the pledging of the debtor’s assets.  

This priority includes claims made, for example, by suppliers of goods and services who sold them to the debtor on a post-payment basis without security. This includes, in particular but not exclusively, claims under contracts (for supply, works, provision of services, loans, etc.) and other agreements on the basis of which the debt arose, provided they are not secured by collateral. 

In other words, any monetary claim against the debtor that is not secured by collateral and does not fall within the preceding groups belongs to the fourth priority.

The fourth priority covers the most common group of creditor claims in bankruptcy proceedings.

Fifth priority for the satisfaction of creditors’ claims 

Under the CUBP, claims relating to the repayment of contributions made by employees to the company’s authorised capital are satisfied in the fifth priority. 

This refers to the return of funds or property contributed by employees to the debtor’s authorised capital. Such claims are satisfied after the claims of creditors in the preceding priority classes have been fully settled within the limits of the available liquidation estate.

Sixth priority for the satisfaction of creditors’ claims 

Under the CUBP, the sixth priority covers other creditors’ claims that have not been classified under the preceding priorities. These typically include: 

• Claims relating to the payment of fines, penalties, forfeits and other financial sanctions; 

• Other additional claims not forming part of the principal debt; 

• Claims which, by their legal nature, do not fall within the first five priority classes. 

In effect, this is the lowest-priority category of claims, which is satisfied after the full repayment of all previous priority classes and only within the limits of the available liquidation estate.

Secured creditors  

The claims of secured creditors deserve special mention. If a creditor holds a security interest in the debtor’s assets (for example, a bank that has granted a loan secured against equipment or property), its claims are satisfied out of turn, i.e. outside the general order of priority.  

In practice, this means that a secured creditor may enforce the security over the collateral (register their right to it), or such property may be realised as part of the bankruptcy proceedings, with a view to satisfying the secured creditor’s claims.  

If the debtor’s assets are insufficient 

If, following the realisation of assets, the funds received are insufficient to fully satisfy the claims of all creditors in a particular priority class, the distribution is made proportionally amongst the creditors in that class. In other words, each creditor receives a share of the amount corresponding to the proportion of their claim relative to the total claims in that class. For example, if a total of UAH 1,000,000.00 in debt has been claimed in the first priority, but only UAH 500,000.00 has been received into the account, then each creditor in this priority will receive half of their claim. 

If, even after proportional distribution, the funds are exhausted, and some claims remain unpaid, such outstanding debts are deemed to have been discharged. In other words, creditors do not receive payment for claims that were not satisfied due to a lack of assets. In the event that the enterprise has no assets at all (or none have been identified), and there is therefore nothing from which to satisfy the creditors’ claims, such claims are deemed to have been discharged, as it is physically impossible to cover the debt.

What determines the order in which claims are satisfied, and is it possible to ‘jump the queue’? 

In practice, businesses often ask us whether it is possible to influence their position in the queue of creditors. The short answer is: the order is determined by law and cannot be arbitrarily changed. 

However, several important factors influence which category a claim falls into: 

• The legal nature of the claim. The order of priority depends on the nature of the claim, as described in detail above. 

• The existence of security (pledge, mortgage). 

The most realistic ‘way to get ahead of others’ is to be a secured creditor. Claims secured by a pledge of the debtor’s property are satisfied out of turn using the proceeds from the sale of that specific property. 

However, it is important to understand that the debtor’s property must be pledged as security prior to the commencement of bankruptcy proceedings. At the same time, it is highly unlikely that one will succeed in artificially classifying the debtor’s property as pledged, as the insolvency practitioner and other creditors will scrutinise the debtor’s recent transactions and may challenge them in court.   

Generally speaking, ‘jumping the queue’ will also not be possible. The law does not permit the established order of priority for satisfying claims to be altered arbitrarily. The insolvency practitioner and the commercial court are obliged to act in accordance with the Code of Commercial Procedure, and any breach of the order of priority constitutes grounds for appeal.

However, there are situations that appear, on the surface, to constitute ‘jumping the queue’: 

• A secured creditor receives payment before other creditors whose claims are settled in order of priority; 

• A settlement agreement or a restructuring plan may provide for a different order and timing of repayment of claims, but only with the consent of the majority of creditors and subject to court approval.

Conclusions 

The order of priority for satisfying creditors’ claims is not a mere formality, but a key factor determining a creditor’s realistic chances of recovering their funds. If you have claims against a debtor and realise that bankruptcy is highly likely, it is important to classify your claims correctly and, where possible, secure them in advance by taking a charge over the debtor’s assets.  

A correctly chosen legal strategy prior to the commencement of bankruptcy proceedings is often decisive in determining who will ultimately receive payment and who will only obtain a formal acknowledgement of the debt by the court.

The following individuals contributed to this article:

• Ihor Selivakin, Senior Associate at Litigation and Dispute Resolution practice at GOLAW, Attorney at law;
• Viktoriia Prokopenko, Junior Associate at Litigation and Dispute Resolution practice at GOLAW.