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If your business is unable to meet its financial obligations, it may be insolvent. Companies facing insolvency cannot treat certain creditors better than other creditors. In other words, they cannot show any preference to one creditor at the expense of others. While there are certain exceptions to this, if a court determines a preference was made, the creditor that benefited from the preference can be ordered to repay the company. This article will explain what a preference by an insolvent company involves and its effects.
Preference by a Company
A preference is any activity undertaken by a company that grants one or more creditors an improper advantage at the expense of the other creditors. A creditor is any person to the company who owes money to or has a security interest or benefit of a guarantee by the company.
Technically, a preference made at any point in time is unlawful. However, only companies in insolvency proceedings have their transactions reviewed. This makes sense, as insolvent companies do not have sufficient assets or cash to meet their liabilities. Therefore, the effect of any preference is only relevant to insolvent companies.
Examples of a Preference
Consider two of the following examples, which are likely preferences.
| Preference 1 | BadCo Ltd has gone into voluntary liquidation following a shareholders’ resolution. Four months ago, in anticipation of the company’s financial difficulty, the company directors agreed to pay off one of the company’s suppliers, ABC Ltd, in full. The directors of ABC Ltd are siblings to one of the directors of BadCo. |
| Preference 2 | NaughtyCo Ltd is financially struggling, and one of its trade suppliers presented a winding-up petition to the court. The application was successful, and the court has placed NaughtyCo Ltd in liquidation. The liquidator has reviewed NaughtyCo’s transactions and discovered that it granted a lender additional security over its assets. However, the lender did not provide any more money in consideration of the additional security. |
Who Can Bring a Claim?
Only a liquidator or administrator can bring a claim against the creditor. A liquidator is the insolvency practitioner the court appoints to oversee a company’s liquidation. On the other hand, an administrator is the insolvency practitioner overseeing an administration.
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Time Limits for Bringing a Claim
The period before the insolvency commences, during which a liquidator or administrator can investigate for preferences, depends on if the creditor was a connected or unconnected person. The period is two years if the creditor is a connected person or associate. If it is an unconnected person, it is six months.
An associate is anyone whose relation to the insolvent company’s director includes:
- a spouse;
- a relative of the director or spouse of the director;
- a business partner;
- an employer or employee;
- certain trustees to trusts; and
- a separate company to which the director is connected.
“Influenced by a Desire to Prefer”
Where the creditor is an unconnected person, the liquidator or administrator bringing the claim must prove to the court that the company was influenced by a desire to prefer when it undertook the transaction with the creditor.
This means that the directors did not act with a mere intention to prefer but a desire. In other words, a company may transact with a creditor in such a way as to prefer the creditor to continue trading. This is not an unlawful preference.
However, if the creditor is a connected person, the law presumes there is a desire to prefer. The company (and its directors) must rebut this presumption. This is a higher hurdle to meet than where the creditor is unconnected. The burden is on the liquidator or administrator to prove it in this case.
Effect of a Preference
If a liquidator or administrator successfully proves a preference, the court can order the preferred creditor to restore the position as if the company had not given the preference. In most cases, this either means the creditor will:
- repay the preference amount; or
- discharge any security it obtained.
Further Considerations
A preference is a claim against a creditor. It is not a claim against the insolvent company or its directors. If a liquidator or administrator has cause to bring a preference claim, they may also bring additional claims against the directors. These claims may include:
- fraud;
- misfeasance; and
- negligence.
Therefore, you should seek advice when your business is facing insolvency. This will minimise your personal civil and criminal liability.
Key Takeaways
A preference is where an insolvent company treats one or more creditors better than the other. A liquidator or administrator can apply to the court to void a preference. As a result, the directors may face additional liability.
If you need help navigating your company’s financial difficulty, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today at 0808 196 8584 or visit our membership page.
Frequently Asked Questions
In some circumstances, yes. But as a director, you assume the substantial risk of continuing to trade without seeking expert advice from an insolvency practitioner or lawyer.
You should seek immediate advice the moment you realise your company may not be able to meet all of its liabilities. An expert can advise you on whether you can continue to trade.
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