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Reviewed by
Christopher Andersen
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Reviewed by Christopher Andersen
Chris is an Insolvency Practitioner regulated by the ICAEW since 2014,. He is experienced in contentious insolvency with excellent analytical skills and strong knowledge of both general and technical insolvency matters.
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15th April 2024

A preference payment is a payment made by an insolvent company to one of its creditors in the period leading up to its liquidation or administration. This payment puts the creditor in a better position compared to other creditors by allowing them to receive more than they would have otherwise received in the insolvency process.

Covered under Section 239 of the Insolvency Act 1986, preference payments are considered preferential if they violate the principle of equal treatment of creditors in insolvency proceedings. These payments are generally viewed as unfair and can be challenged by the liquidator or administrator.

Preferential Payments During Insolvency
Contents
  1. What Payments Qualify as Preferential During Insolvency?
  2. What Happens if you Make a Preference Payment When your Company is Insolvent?
  3. What To Do If You Have Given A Preference Payment?
  4. FAQs on Preferential Payments

What Payments Qualify as Preferential During Insolvency?

It’s important to note that not all payments within the statutory time periods are automatically preferential. The key factors are whether the payment had the effect of preferring one creditor over others and whether the company was insolvent or became insolvent as a result of the payment.

Broadly speaking, the following types of payments are likely to be considered preferential:

  1. Payments to unsecured creditors: Any payments made to an unsecured creditor (e.g., trade suppliers, contractors, service providers) within the 6 months preceding the company’s insolvency can be classified as preferential. This includes one-time payments as well as a course of preferential payments over the 6-month period.
  2. Payments to connected parties: Payments made to parties connected to the company (e.g., directors, shareholders, associated companies) within 2 years before insolvency can be deemed preferential.
  3. Unusual or out-of-the-ordinary payments: Even if within the statutory time limits, payments that deviate from the company’s normal trading practices or payment patterns may be considered preferential. For example, paying a supplier in full rather than adhering to agreed credit terms.
  4. Payments creating new security interests: Granting new security interests, charges, or guarantees over company assets to secure existing debts within the relevant time period can amount to a preferential payment.
  5. Substantially larger payments than normal: Payments significantly larger than the company’s typical payments to that creditor, without a reasonable commercial explanation, may be viewed as preferential.

What Happens if you Make a Preference Payment When your Company is Insolvent?

If your company enters into insolvency proceedings (such as administration or liquidation), an insolvency practitioner (IP) will be appointed to manage the process. Part of the IP’s duties includes reviewing transactions made before the insolvency to identify any preference payments.

The term pari passu is a Latin phrase that means “on equal footing” and is fundamental in the context of insolvency proceedings. It refers to the principle that certain creditors or claims must be treated equally, without any preference, and share proportionately in the distribution of a company’s assets or the proceeds from their liquidation.

If the IP determines that a payment qualifies as a preference, they can seek to reverse the transaction. This involves legally challenging the payment and potentially obtaining a court order to have the funds returned to the company’s estate.

Directors who authorise preference payments can face serious consequences:

What To Do If You Have Given A Preference Payment?

If you have given a preference payment as a company director while the company was insolvent or close to insolvency, there are some important steps you should take:

  1. Disclose the payment to the insolvency practitioner: Be upfront and disclose the preference payment to the liquidator or administrator appointed to handle the company’s insolvency. Trying to conceal the payment could lead to allegations of misconduct and potential personal liability.
  2. Gather supporting documentation: Collect all relevant documentation and records related to the preference payment, such as invoices, payment receipts, communication with the creditor, and any evidence of the company’s financial position at the time of the payment.
  3. Cooperate with the investigation: If the insolvency practitioner investigates the preference payment, fully cooperate with their inquiries, provide requested information, and follow their instructions.
  4. Consider repaying the preference: In some cases, the insolvency practitioner may give you the option to repay the preference payment to the company’s estate voluntarily. This could help mitigate potential claims against you for recovery of the payment or allegations of misconduct.
  5. Defend your actions if necessary: If the insolvency practitioner decides to take legal action to recover the preference payment, be prepared to defend your actions and provide evidence that the payment was made in good faith and without the intention to prefer one creditor over others.

It’s crucial to act transparently and proactively when it comes to preference payments. Attempting to conceal or defend an unjustified preference payment can lead to serious consequences, including personal liability for the company’s debts, disqualification as a director, and potential criminal charges in cases of fraud or misconduct.

FAQs on Preferential Payments

 Insolvency can be determined based on either the cash flow test (inability to pay debts as they fall due) or the balance sheet test (liabilities exceeding assets). The insolvency practitioner will examine the company’s financial records to establish the date of insolvency.

Yes, in some cases, preference payments can still be set aside even if the company was not technically insolvent at the time of payment, as long as the payment caused the company to become insolvent.

The insolvency practitioner will consider factors such as the nature of the business, the commercial relationship with the creditor, and industry norms to determine if a larger payment had a legitimate commercial justification or was preferential.