As ‘all animals are equal’ in the novel Animal Farm by George Orwell, ‘all creditors are equal’ in insolvency should directors wish to avoid assertions involving unfair preference payments.
For a director, such an unfair preference claim can lead to personal liability to the value of the preference payments made to creditors, providing they were made whilst the company was insolvent, or the company became insolvent as a result of such payments. These transactions are also scrutinised by The Insolvency Service when determining if a director should be disqualified from acting as a director in the future.
Therefore it’s important for directors to treat all creditors equally (pari passu) once insolvency threatens.
Preference payments to creditors
Broadly speaking, a preference occurs when the company does anything or suffers anything to be done which (in either case) has the effect of putting a creditor into a position which, in the event of the company entering an insolvency process, will be better than the position they would have been in had that ‘thing’ not been done (making ‘some more equal than others’, chapter ten!). The ‘thing’ in this context is often a physical cash payment, but could equally be the transfer of an asset in settlement of, or part payment of, a liability.
For example:
- A preference payment is made to a key supplier to promote an ongoing business association with the directors after insolvency
- A loan is repaid to a connected party of the company or its directors i.e. a board member, employee, business partner, relative or friend
- The repayment of a loan that has been personally guaranteed by the directors which indirectly benefits them
In all instances, for a preference claim to succeed, it must be demonstrated that there was a desire (from the directors’ perspective) to prefer that person or creditor. Such a desire is sometimes more obvious than others and where the transaction in question involved a connected party, the desire to prefer is presumed.
Assessment of preference payments to creditors
The period of time between the transaction and the date of insolvency, is central to whether a payment may be deemed as a preference.
The date of insolvency may be when a company Administration Order is made, the filing date of a Notice of Intention to Appoint, or the start date of winding-up process.
Where a repayment was to a connected party, the timescale under consideration is two years ending with the onset of insolvency, and for a non-connected party, six months.
Preference payment advice
To avoid personal liability and even disqualification, always document payment reasons to show the commercial justification for payment.
If you are uncertain about preference payments in insolvency or you would like to know more in relation to your situation, contact us for some free no obligation advice, 0121 201 1720.
*You may also be interested in the creditors order of payment, when an insolvency practitioner has funds to distribute.
