Preference in Liquidation – Why You Need to Avoid Making Preferential Payments to Creditors

Once a company becomes insolvent or enters an insolvency procedure, the activities of directors up to the time of liquidation, if undertaken, will be investigated to identify unlawful or wrongful actions.

During this period, preferential payment is one of the type of transaction that will be investigated.

It is the duty of directors to maximize financial returns to all creditors once they become aware that the company is insolvent or threatened by insolvency – any inappropriate action during this period is considered unlawful.

As a director, you must set aside your interests and that of the company, and following the ‘pari passu’ principle, you must ensure all creditors within each level receive equal treatments regarding repayment/losses.

What is a preferential payment?

Preferential payment is said to happen when a particular creditor receives special or more beneficial treatment than other creditors within the same group.

This occurs when a creditor is positioned in a place that is more beneficial to that creditor, while other creditors within the same group suffer harm or loss.

For instance, ensuring that a creditor receives payment merely to promote an ongoing business relationship after insolvency, or when the company repays a loan to an individual linked to the company, like a friend or relative of the director.

A director, for instance, may be tempted to repay a loan first to protect their personal finances if he or she has provided a specific lender with a personal guarantee.

This can also be seen as preferential payment in insolvency. Besides cash payments, preferential payment also includes the transfer of company assets.

Parameters to judge if a payment is preferential

To know if a payment is considered preferential, you need to consider the time frame between the transaction as well as the onset of insolvency. This involves two aspects:

• If a connected recipient or party, like the director’s relative, is involved in the transaction, the timescale is two years before the company being insolvent
• The time scale is six months for non-connected parties or recipients

The insolvency date could be the date on which the winding-up starts, the filing date of Notice of Intent to Appoint, or when the petition for an administration order is presented.

There are certain occasions where a payment that was indeed preferential be disregarded; a preferential payment could be overlooked merely because of the timescale in situations if the company has struggled on for some time without becoming insolvent.

Consequences of making preferential payments

If a preferential payment is discovered, directors are likely to suffer personal liability for all or some of the company’s debts.

During the process of liquidation, the assigned insolvency practitioner is bound to look into the activities of the directors during the time leading up to insolvency.

And if found guilty of wrongful or unlawful actions, like a preferential payment, actions may be taken against you.

If the company became insolvent as a result of preferential payment or a preferential transaction took place when the company was insolvent, you can be disqualified from being a director for 15 years.

Next steps

To know more about preferential payments in insolvency, and to make sure you are not taking unlawful or wrong actions as a company director, contact us today.

Our experts can advise whether your actions as a director might be scrutinized, and deliberate on available options.

We operate nationwide and can also provide a same-day consultation in total confidence for free.

Call us on 0800 975 0380 or email [email protected]