Insolvency ‘preference’ payments: What directors should be aware of

A ‘preference’ occurs when a company facing insolvency puts a specific creditor, or group of creditors, into a better position than the other creditors. A preference can be a payment as well as a transaction, such as granting a charge over assets. A director could face personal liability if a preference has been made, which could result in the director being disqualified for a period of up to 15 years.

What’s classed as a preference?

A payment or transaction could be classed as a preference if:

• It was made when the company was unable to pay its debts, within the meaning of S123 of the Insolvency Act 1986.
• The company becomes unable to pay its debts, within the meaning of S123 of the Insolvency Act 1986, as a consequence of the preference.
• It occurs within the relevant time period before the onset of the insolvency. This is up to two years before the onset of the insolvency if it involves a connected party, or six months for unconnected parties.

The company must also have ‘desired’ to prefer the creditor. This means that the company must wish to put that creditor in a better position. There is an automatic assumption that the company was influenced by desire if the preference was to a connected party.

Some examples of preferences include:

• Repaying a loan to someone connected to the company, such as a relative.
• Repaying a debt that is personally guaranteed by the director.
• Paying a creditor to encourage an ongoing business relationship after the insolvency of the existing company.
• Creating a charge over assets, thus putting that creditor into a better position.

What are the consequences of a preference?

If the company subequently enters into an insolvency process such as administration or liquidation, the appointed Insolvency Practitioner has a duty to investigate the affairs of the company and the conduct of the directors to find out if they’ve acted wrongfully, and if any preference transactions have been made.

If any actions are deemed to be preferences during the relevant time period, the Insolvency Practitioner will look to restore the position to what it would have been, had the company not given that preference. They may try to recover the funds from the recipient, or if that’s not possible, request a compensatory amount from the director. If the company had created a charge over assets, the Insolvency Practitioner would look to void that charge.  

The Insolvency Practitioner is also required to submit a Director Conduct Report which may result in the director being disqualified for a period of up to 15 years.

What should directors consider?

As most businesses have now returned to full trade following lockdown, directors need to make sure that they act responsibly, especially if they consider the company to be insolvent or there’s a possibility of insolvency. The directors have a duty to the creditors as a whole; they must treat all creditors equally, following the pari passu principle, and avoid any actions that could worsen a creditor’s position.

However. sometimes it’s necessary to pay one creditor over another whilst insolvent, if that creditor is key and it would be impossible to trade without their continued supply. An example would be an electricity supplier, who’s needed to make sure that a warehouse can continue to run, resulting in orders being fulfilled and additional income being received by the company.

If such payment is made, the directors must record their decision for making the payment within the company records.

This is a complex area, and if the director is unsure, they should obtain advice.

What should you do?

If your company is struggling financially, contact an Insolvency Practitioner for help.

Hold regular board meetings, and make sure all key decisions are evidenced. Regularly review the financial position of the company, ensuring the information used is reliable. When making payments, consider the appropriateness of each payment and whether it may constitute a preference. If there’s any doubt, seek advice.

If you have any queries regarding preference payments and the financial position of your company, please contact our Insolvency & Recovery team. You can find our contact details in the Our People section on our website. Alternatively, call 0330 024 0888 or email enquiry@larking-gowen.co.uk.

Rebecca Bloomfield