Preference

UK legislation sets out a number of transactions that can be set aside in the event of insolvency, a key one being a preference under s 239 Insolvency Act. This article sets out what a preference is and how to deal with a situation where this may be alleged.

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What Is a Preference Under s 239 Insolvency Act?

Your business is failing and you owe your parents the loan they gave you at the outset, as well as your unpaid suppliers. With the last cash you have in the bank, you pay your parents back, and the key supplier that you will need onside if you are going to start trading again afterwards, and then you call in the Liquidator.

Unfortunately however, you have just committed at least one preference under s 239 Insolvency Act, and probably two. Worse still, the appointed liquidator will be under a duty to examine these transactions and where appropriate they can seek a Court order to set them aside, which may also involve you being liable to contribute to the company’s assets and it will also be a matter for inclusion in your statutory directors’ disqualification report.

A company gives someone a preference under s 239 Insolvency Act if during the relevant period it:

does anything (or allows something to be done);
which puts that person in a better position than they would otherwise have had in the insolvency; and
the company which gave the preference was influenced by a desire to improve the person’s position by doing so.

This is often referred to in summary as ‘a desire to prefer’ and cover actions such as paying creditors or settling sums which may have been personally guaranteed.

What Period Of Transactions Are At Risk?

Transactions can be attacked if they take place during the ‘relevant time’ preceding ‘the onset of insolvency’ which in practice means the start of the formal insolvency proceedings which have led to the liquidation.

The relevant time for this purpose is:

generally set at six months, but is extended to two years in the case of transactions with connected parties, which includes the directors, shadow directors and their, and the company’s associates which is covers a wide range of people including relatives, employees and beneficiaries of trusts; but only if
the company is insolvent at the time, or would become insolvent as a result of the preference being made.

What Is The Impact Of a Transaction Being Held To Be a Preference Under s 239 Insolvency Act?

The courts have wide powers in the event of a preference under s 239 Insolvency Act being proved top make any order it sees fit to restore the position to what it would have been if the preference had not been made. Such orders can include the return of property or payments to the company and can result in directors being held personally liable for the sums involved.

Where a preference in alleged in respect of a connected party, the normal burden of proof is reversed in that it will be up to the connected party to prove that the payment or transaction was not intended to be made as a preference.

The liquidator will make reference to any preferences identified in their Directors Disqualification report which may lead to proceedings being brought.

How Should I Deal With Making Payments to Creditors?

The basic rules here are simple.

if you are at all concerned about whether your business is insolvent and the issue of whether payments are a preference, then you should be taking appropriate professional advice.
The overall principle has to be that all creditors should as far as possible be treated equally when it comes to making payment.

Commercial pressures can sometimes however mean that this is not possible. For example you may face a need to make payments to a key, unconnected, supplier of raw materials in order to maintain production and this may well be commercially justifiable in that it allows you to continue to trade in the interests of all creditors. In this circumstance the decision to make a payment is unlikely to be held to be a preference as it is not motivated by a desire to prefer that creditor but by the commercial logic of the situation.

In this type of situation you need to keep clear records of the payments that are being made and their rationale so that if challenged, you can demonstrate the reasons they were made.

Of course the information contained in an article like this can never be a full statement of the legal position as the relevant laws are complex and liable to change. This article can only therefore be a general guide as to the issues involved and as these can have serious implications you should always seek appropriate professional advice on your own particular circumstances before taking any action.