What happens if you make a preference payment when your company is insolvent?

A preference payment occurs when an insolvent company pays one creditor before others, giving that creditor a better financial position than they would have had otherwise. This breaches your duties as a company director, and these transactions may face challenges during the company’s liquidation process.


What do we mean by preference payment?

A preference payment is a transaction made by an insolvent company to a specific creditor, aiming to put that creditor in a more advantageous financial position than they would have been otherwise.

Upon realising your company is insolvent, or if there are signs it’s heading that way, as a director, it’s your duty to ensure you do everything possible to maximise the financial return to all your creditors. This implies refraining from any actions that could worsen their situation and ensuring equitable treatment for all creditors.

This entails refraining from using company funds to settle one debt if you cannot meet all outstanding creditors; such action, known as making a preference payment, constitutes a serious violation of your responsibilities as a company director.


What could be the reason for making a preference payment?

If your company is insolvent, making a preference payment will not enhance your company’s prospects. Nonetheless, you might feel tempted to do so out of loyalty to a specific creditor or to ensure repayment to friends and family who are owed money by your company.

You might also feel inclined to prioritise repaying borrowings secured with a personal guarantee to safeguard your personal finances when your company faces liquidation. 

Despite justifications you may provide to yourself, such transactions violate the Insolvency Act 1986 under section 239.


What’s the processes of creating and challenging unfair preference?

An unfair preference may arise when the creditor is a family member or friend of a board member, for instance. 

Creditors who are family members are termed ‘connected creditors’. There might also be a vested interest or commercial advantages in prioritising payment to specific creditors before liquidation, especially if directors plan to maintain relationships with certain suppliers in a new business venture.

Throughout the liquidation process, it’s the responsibility of the insolvency practitioner to meticulously examine all transactions of the bankrupt company, ensuring that other creditors haven’t incurred financial losses due to any preference payments made while the company was insolvent.

In cases involving a connected party, the presumption of intention to prefer applies, and such transactions can be contested up to two years after their occurrence.

In other instances, though, the reasons for unfairly paying a specific creditor will demand thorough investigation by the insolvency practitioner, who must demonstrate that an intention to prefer motivated the transaction.


All about Pari Passu [An equitable distribution of funds]

Insolvency law upholds a principle called ‘pari passu,’ ensuring equitable distribution of assets and funds among creditors, with no preferential treatment given to unsecured creditors.

The company liquidator will complete payments made within six months of entering formal insolvency proceedings. If an unfair preference transaction is suspected, they may initiate recovery actions. For payments to a ‘connected creditor,’ the time limit extends back two years before the commencement of winding-up proceedings.

Besides family members, other connected parties could comprise an employer or employee, a business partner, or another director of the company.


What are the powers of the liquidator to challenge a preference payment? 

If a preferential payment is discovered during the liquidator’s investigations, they have the authority to petition the court for an order to reclaim the funds. The responsibility for proving the case varies depending on whether the creditor was a connected party, such as a family member.

The liquidator is responsible for demonstrating that a deliberate preference has been established unless the transaction involves a connected party. In such cases, the connected creditor must prove that no intentional preference was created and that they were unaware of the company’s insolvency or approaching insolvency.


Preference payments during my company’s insolvency

Directors are obligated to be aware of and comprehend their company’s financial status consistently. If they’re unable to settle their debts promptly or if their liabilities surpass their assets, the business is considered insolvent.

Directors must seek the professional advice of an insolvency practitioner and prioritise the interests of all creditors over their own and the company’s once they are aware, or should be aware, of the company’s insolvency. Continuing to trade when the company is knowingly insolvent can constitute wrongful trading.

If a director intentionally shows interest towards certain creditors, the courts might require the recipient of the preferential payment to return the money to the insolvent company, restoring its pre-payment financial position.


What are the repercussions of making a preference payment?

Throughout the liquidation process, the designated insolvency practitioner is obligated to scrutinise the actions of the company’s directors in the period preceding its insolvency and its subsequent entry into liquidation.

As part of this process, all transactions into and out of the business will be examined. If a preference payment is suspected, the director will be questioned about it as the initial step.

 If it is judged that the director deliberately aimed to create a preference by favouring particular creditors, then the courts may order that the recipient of the preference payment returns this money to the insolvent company to restore it to the position it was in before the preference payment was made. 


How can I avoid making a preference payment?

If you suspect your company has reached or is nearing insolvency, seek assistance from a licensed insolvency practitioner. Avoid attempting to resolve the situation independently or relying on the issues to resolve themselves.

While preference payments are prohibited, there are instances where you may be allowed to pay certain creditors even when insolvent, provided these payments benefit the company and its remaining creditors.

An example of this could be settling the electricity bill to keep the office operational, thus enabling the collection of debtor payments. Nevertheless, the regulations regarding this matter are intricate, and it’s advisable to seek professional guidance before making any payments if uncertain whether they might be deemed preferential.


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How can Vanguard Insolvency help you? 

If your business is facing financial challenges and you’re concerned about its future, reach out to the specialists at Vanguard Insolvecny. 

With a nationwide team of over 70 licensed insolvency practitioners, we can assist you in navigating through your current difficulties. Contact our team to schedule a free, no-obligation consultation with your nearest Vanguard Insolvency office.

Senior Partner at Vanguard Insolvency Practitioners | Website | + posts

I am an insolvency professional with a distinguished career specialising in commercial insolvency, adeptly navigating Creditors Voluntary Liquidation, Company Voluntary Arrangements, and Company Administrations. With a comprehensive understanding of insolvency laws and an unwavering commitment to ethical practices.