What Are Preference Payments?
A preference payment occurs when an insolvent company pays a specific creditor, giving them an advantage over others.
This practice breaches insolvency laws, as it prioritises one creditor’s interests over the collective rights of all creditors.
Under Section 239 of the Insolvency Act 1986, such payments are closely scrutinised during insolvency proceedings.
If identified, they can be reversed by the liquidator to restore fairness.
Why Are Preference Payments a Concern?
Directors have a legal duty to act in the best interests of creditors when their company is insolvent.
Preference payments can be deemed a serious breach of this duty and may result in personal liability or director disqualification.
Examples of Preference Payments
Some common examples include:
- Repaying loans to family members or directors.
- Covering an overdraft with a personal guarantee.
- Paying key suppliers to secure future business relationships.
- Transferring assets to a creditor.
- Prioritising debts owed to connected parties, such as employees or business partners.
In these scenarios, the intention to prefer the creditor is presumed if the transaction involves a connected party.
How Are Preference Payments Identified?
Preference payments are typically identified during the liquidator’s investigation. A liquidator will:
- Examine the company’s financial records for transactions in the months leading up to insolvency.
- Determine the company’s solvency at the time of payment.
- Assess the intent behind the payment to establish whether the director sought to create a preference.
For payments to connected parties, such as family members, the burden of proof lies with the creditor to demonstrate that no preference was intended.
Legal Timeframes for Preference Claims
The timeframe for challenging preference payments depends on the recipient:
- Unconnected creditors: Transactions within six months prior to insolvency can be reviewed.
- Connected creditors: Transactions within two years prior to insolvency are subject to scrutiny.
What Are the Consequences for Directors?
If a preference payment is identified, the consequences can be severe:
- Reversal of payment: The creditor must return the funds to the insolvent estate.
- Personal liability: Directors may be held accountable for losses caused by the payment.
- Disqualification: Directors can be banned from serving as company directors for up to 15 years.
How to Avoid Making a Preference Payment
To ensure compliance with insolvency law:
- Seek professional advice: Engage a licensed insolvency practitioner when financial difficulties arise.
- Treat creditors equitably: Avoid favouring one creditor over others.
- Document financial decisions: Maintain clear records of all payments and their rationale.
What If You’ve Already Made a Preference Payment?
If you suspect a preference payment has been made:
- Notify your insolvency practitioner immediately.
- Provide full transparency to aid their investigation.
- Work collaboratively to address any potential breaches of insolvency law.
Conclusion
Understanding and avoiding preference payments is essential for directors of insolvent companies.
Acting in the collective interests of creditors is not just a legal requirement but also a vital step in maintaining trust and integrity during financial distress.
For tailored advice on insolvency and compliance, contact our team of experts today.
FAQ’s: Preference Payments
What Is an Example of a Preference Payment?
An example is repaying a loan to a family member while other creditors remain unpaid. This prioritises the relative’s interests over those of other creditors.
How Can Directors Avoid Making Preference Payments?
Directors should seek advice from a licensed insolvency practitioner, treat all creditors fairly, and avoid favouring connected parties.
What Happens If a Preference Payment Is Made?
The liquidator may reverse the payment, require the creditor to return funds, and investigate the director’s actions, potentially leading to disqualification.
What Is the Time Limit for Challenging Preference Payments?
For unconnected parties, the limit is six months before insolvency. For connected parties, the period extends to two years.
What Are Connected Creditors?
Connected creditors include family members, employees, business partners, or other directors. These transactions are subject to stricter scrutiny.
