What Are Preferential Payments? A UK Director’s Guide Under the Insolvency Act 1986

Two months before the liquidator was appointed, the director cleared a £40,000 loan his wife had made to the company in 2019. The payment came out of the trading account on a Friday.

The Barclays app showed the transfer, the bookkeeper coded it, and nothing felt wrong at the time. Three months later, the liquidator is on the phone asking why his wife was paid when the VAT was not.

This is the shape of a preference claim.

Under section 239 of the Insolvency Act 1986, which applies to companies in England and Wales, a payment made by an insolvent company that puts one creditor in a better position than others can be unwound by the liquidator, with the court ordering repayment. Scotland has different rules on unfair preferences.

The test is narrow, the lookback is long, and the presumptions for connected parties are against you.

Most preference claims are not about fraud. They are directors paying the creditor who was easiest to face: the spouse, the family friend, the landlord, the bank with your personal guarantee.

The liquidator does not need to prove fraud against you. They need to prove the four elements of section 239, and if the recipient is connected to you, the “desire to prefer” is presumed.

What Counts as a Preferential Payment Under Section 239

Section 239 of the Insolvency Act 1986 gives liquidators (and administrators) the power to apply to court to unwind a preferential payment your company made before it entered insolvency.

Four elements must be established against you.

First, your company was insolvent at the time of the payment, or became insolvent as a result of it.

Insolvency here is either cash-flow insolvency under section 123(1)(e) IA 1986 (cannot pay debts as they fall due) or balance-sheet insolvency under section 123(2).

See our guide on how to check if a company is insolvent for the working test.

Second, the recipient was a creditor (or a surety or guarantor for a company debt).

Third, the payment put the creditor in a better position, in the company’s later insolvent liquidation, than they would have been in if the payment had not been made.

Fourth, the company was influenced by a “desire to prefer” the recipient over other creditors. This is the central test, and it is the element Re M.C. Bacon Ltd [1990] BCC 78 settled for good.

Desire means a positive wish to improve the creditor’s position. Commercial pressure, on its own, is not desire, which is why Millett J held that the debenture the company gave its bank in Bacon was not a preference.

The director had no positive wish to prefer the bank; he just wanted to keep the company alive.

The Preferential Payment Lookback: 6 Months and 2 Years

Section 240 IA 1986 fixes the “relevant time” for preference claims against your company. If the recipient is not connected with you, the lookback is 6 months from the onset of insolvency.

If the recipient is connected with the company (a director or shadow director, a director’s spouse, civil partner or relative, or a company under the same control), the lookback is 2 years. A person connected only because they are an employee is not caught by the 2-year rule.

Connected creditors also carry a statutory presumption under section 239(6): the company is presumed to have been influenced by a desire to prefer them, unless you can prove otherwise. This puts the burden of proof on you.

In an unconnected case, the liquidator must prove desire. In a connected case, you must disprove it.

The onset of insolvency is defined in section 240(3). In a compulsory liquidation it is usually the date the winding-up petition was presented; in a creditors’ voluntary liquidation, the date the resolution was passed.

In administration it is the date the court application was made or the notice of intention to appoint was filed, or, if no notice of intention was filed, the date the appointment took effect. If liquidation follows straight on from administration, the onset goes back to the administration date. You need to identify that date on your calendar and work backwards.

Common Preferential Payment Patterns We See

The patterns are surprisingly consistent. These five are common grounds for preference claims.

Clearing your director’s loan account. An overdrawn DLA becomes a debt you owe the company and has to be repaid.

A credit DLA becomes a debt from the company to you, and directors often pay themselves back in the final months. Both sides of this trigger scrutiny: one as an asset the liquidator will chase, the other as a preference.

Paying off the bank where you have given a personal guarantee. Your home is on the line under the PG. You pay down the bank facility to reduce your PG exposure, often while the VAT is already in arrears.

The effect is to reduce your own guarantee at the expense of other creditors, and the liquidator is likely to challenge it.

Repaying a loan from a family member. The parent or spouse who lent £30,000 two years ago is paid in the final weeks. Because the lender is connected, the lookback is 2 years and the desire to prefer is presumed.

Giving new security for an old debt. Granting a charge over the company’s plant and machinery to secure an existing unsecured loan, in the weeks before insolvency.

This can be challenged as a preference under section 239. If the new security is a floating charge, it may also be invalid under section 245.

Paying a critical supplier in full while others wait. Less clear-cut.

Where the supplier was genuinely essential to trading and the payment was driven by commercial necessity (no supplier, no trade, no chance of rescue), the Bacon test usually saves it.

Where the supplier is a family business, it is usually connected with the company, so the desire to prefer is presumed and you must show otherwise. Where it is a friend’s business, there is no presumption, but the liquidator will look closely for evidence that you wanted to help them.

Consequences of an Unwound Preferential Payment

If the court finds a preference, the remedies under section 241 IA 1986 are wide. The most common order is that the recipient repays the sum to the liquidator.

Where the recipient is a surety, the court can restore the guarantee. Where the recipient has sold the asset on, the court cannot take it back from a buyer who paid for it in good faith, but it can order the recipient to pay its value to the liquidator.

For you as director, the consequences layer up. First, if the payment also involved misapplication of company money, there is a section 212 IA 1986 misfeasance claim.

Second, if you kept trading after there was no reasonable prospect of avoiding insolvent liquidation and creditors’ losses grew, you may also face a wrongful trading claim under section 214, unless you took every step to minimise their losses.

Third, your conduct is reported to the Insolvency Service under section 7A CDDA 1986. A preference to a connected party is a common ground for disqualification proceedings or an undertaking. A disqualification lasts between 2 and 15 years, depending on how serious the conduct was.

In our files, where the preferred creditor is a family member and the payment is reversed, the family member usually cannot repay.

The shortfall then often falls back on you personally through a parallel misfeasance claim, because you “caused” the company to make the payment.

This is why preference defences matter. The real question is not whether the recipient loses the money, but whether you absorb the shortfall.

Defences to a Preferential Payment Claim

Your strongest defence is the Bacon defence: no desire to prefer.

The payment was driven by commercial pressure (the supplier refused further deliveries, the landlord threatened forfeiture, the bank froze the facility), not by your wish to improve the creditor’s position.

Contemporaneous evidence matters. Your emails, file notes, and Board minutes carry the weight. A solicitor’s letter threatening statutory demand the day before the payment is the kind of evidence that turns a preference into ordinary-course trading.

The second defence is evidence of ordinary trading. Routine supplier payments made on normal terms, while the company was meeting its other obligations, are harder to attack, because they are good evidence that there was no desire to prefer.

In the cases we take on after liquidation has begun, we regularly advise directors to pay all creditors proportionately rather than prioritising the loudest one.

Your third defence is that the company was not insolvent at the relevant time.

If you can show, with reasonable management accounts and a realistic cash forecast, that the company could pay its debts as they fell due and its assets exceeded its liabilities at the date of the payment, and that the payment itself did not tip it into insolvency, the section 239 claim fails.

This is evidentially difficult in the last six months before liquidation, but not impossible.

Your fourth defence is that the recipient was not a creditor. Paying in advance or on delivery for new goods or services is not a preference, because the company gets fresh value and the supplier is not owed an old debt.

Paying a landlord’s rent arrears or a supplier’s old invoices is different: those are creditors, and the payment can be a preference if the other elements are met.

How Preferential Payments Differ From Legitimate Priority Creditors

This is worth separating, because the language confuses directors. “Preferential creditor” under Schedule 6 IA 1986 is a statutory ranking. Employees rank as ordinary preferential (capped at £800 in wages arrears).

HMRC ranks as secondary preferential for VAT, PAYE income tax, employee National Insurance, student loan deductions and CIS deductions since 1 December 2020. Employer National Insurance and corporation tax stay unsecured. Paying those creditors in full in a normal trading month is lawful.

“Preferential payment” under section 239 is different. It is any payment to any creditor that improves that creditor’s position ahead of the insolvency and is influenced by a desire to prefer.

An employee with £5,000 in arrears could, in theory, be the recipient of a preferential payment if you paid them in full with a desire to prefer them over other creditors.

In practice, the Schedule 6 ranking makes that unlikely to be challenged, because the employee would have been paid first in liquidation anyway.

The test is always the same: did the payment change the outcome for the creditor, relative to what liquidation would have produced? If the answer is no, there is no preference.

If the answer is yes, all the usual elements apply. For broader context, see our guide on the preferential versus non-preferential creditor waterfall.

Your Next Step

If you are a director who has made payments to connected parties in the last two years, or to any creditor in the last six months, and insolvency is now on the horizon, this is a time-sensitive decision.

Two groups again.

If the only “preferential” payments you can identify were ordinary supplier payments, routine payroll, and HMRC remittances made in the course of trading, your section 239 exposure is low.

The Bacon test protects you, and a competent IP will file a neutral conduct report. You do not need urgent advice; you need to complete your PIQ accurately when it arrives.

If you paid down your own DLA, cleared a family loan, reduced a bank facility covered by your PG, or granted new security for an old debt, your exposure is real. You have three options and only one window.

Option one: do nothing, and defend the claim when it arrives, usually 6 to 12 months after appointment.

Option two: engage the IP early and negotiate a reversal before proceedings issue, which can reduce or eliminate your costs exposure.

Option three: restructure the payment now, before insolvency crystallises, if solvent rescue is still feasible.

For most directors in group two, option two is cheaper than option one. Call us on 0800 074 6757 before the liquidator’s solicitor does.

We can review the transactions, model your section 239 exposure, and tell you within a call whether your payment is Bacon-defensible or a concession case. For related risks, see our guide on misfeasance claims.

FAQs on Preferential Payments