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What Is A Preference Under The Insolvency Act 1986?

14th June, 2021

Written ByGary Weber

Turnaround & Insolvency Manager (South)


07739 325 008

Gary has been with KSA since late 2010 and is now overseeing the work of all our Regional Managers as well as covering his own patch of the South East. He is passionate about helping companies having been an owner and a director of a number of businesses in industries including pubs, catering, road haulage, and retail. Gary drives our rescue work throughout central and west London, Surrey, W.Sussex, Berks., Bucks. and Oxon.

Gary Weber
  • A straightforward guide to s239 Insolvency Act 1986 – or s243 Unfair Preferences in Scotland
  • So how does preference happen?
  • How do we avoid creating a preference?

A straightforward guide to s239 Insolvency Act 1986 – or s243 Unfair Preferences in Scotland

A potential “preference” occurs when a company pays a specific creditor or group of creditors(s) and by doing so makes that creditor “better off” than the majority of other creditors, before going into a formal insolvency like administration or liquidation. However, the second important test is that there must be a “desire” to make that particular creditor better off.

This is an area of insolvency law that is commonly misunderstood, but can cause many problems for those who create the preference. If the preference is proven it can lead to action against the beneficiary, the directors, lifting of the veil of incorporation, personal liability and if wrongful trading proven, disqualification under other provisions of the insolvency legislation.

So how does preference happen?

A fictional case study for a preference under s239 Insolvency Act 1986

Acme Nuts and Bolts Company Ltd, has been trading for many years and has seen a steady decline in sales and profits over recent times. Mr Bolt, the managing director, sits down with Mr Washer the financial director, and they read the accounts, look at the cashflow and decide that the company is insolvent. It is likely that the company will breach the bank overdraft if all creditors demands for payment are met. The PAYE is already 2 months behind and the most recent VAT quarter has not yet been paid.

Mr Bolt thinks that a smaller and leaner workforce, operating in a much smaller property would be a viable business but the company’s long term employees would be too expensive to pay off. Redundancy costs alone would be £100,000. They cannot see how to pay this and decided to slowly wind the company down before starting again.

One of the suppliers to Acme is a company owned by Mr Bolt’s brother, it is owed £12,000 for supplies in the last 30 days, and has always been paid on time by Acme. Another supplier is owed £16,000 and it has a smaller factory property available, that Mr Bolt would very much like to use to start a new company.

Mr Bolt tells Mr Washer to pay both these amounts as soon as possible and then he decides that they will talk to an insolvency practitioner about the options for “dumping the company”. Some 8 weeks later the company enters liquidation and the liquidator begins to examine the conduct of the company in the period leading up to the liquidation.

He discovers that Mr Bolt’s brother was paid £12,000 and the other supplier was paid £16,000, just before the company decided to cease trading and go down the liquidation path. VAT, PAYE and over £500,000 worth of other creditors debts were not paid.

Under s239 insolvency Act, the payment to Mr Bolt’s brother is a clear breach of the Act, both tests were positive, the company paid the debt when not paying PAYE/VAT and other creditors. Now the more difficult test – was their a desire to create a preference”?

Because the brother was a “connected creditor” or associate through blood, the law automatically assumes that Mr Bolt wanted to make his brother better off. The liquidator demanded the money back from Mr Bolt’s brother and the court agreed.

On first inspection by the liquidator, the other payment to the company with the spare property was less clear cut. Was a payment made? Yes. Was it paid when other creditors were not paid? Yes. Was a desire to create a preference in place? Possibly but not conclusively. However, after a few weeks the liquidator noted that Mr Bolt had started a new company and the address was the same as the paid customer of Acme, so he took action to recover that money too. Interestingly, some of the company’s assets appeared to have mysteriously found their way to that property too!

The “desire to create a preference” test is much more difficult to prove in other cases, often the threat of the liquidator taking action sees a deal being done where some of the debt is repaid, to the liquidator, for the benefit of other creditors.

This is a difficult subject matter but a vitally important one for every director to consider when reviewing the company’s insolvency and how they have acted.

This is a path that requires professional advice, common sense and full discussion by the board, and proper documentation of decisions to pay suppliers taken at board and management levels.

Clearly, paying friends and family is risky. Paying back directors’ loans is a preference if the company subsequently enters liquidation.  Remember it is the word “desire” that is key.  So paying a creditor that is a absolutely critical to the continued business such as a web hosting company for an e-commerce site is more of a commercial decision than a “desire” to help the hosting company.

Finally, remember though that preferences are only crystallised by a formal insolvency like administration and liquidation.

How do we avoid creating a preference?

Common sense dictates that if the decision to pay someone seems “off” it usually is!

The safest route is to ensure that all creditors are treated “equally”. If that is not possible then ensure that if one creditor is being paid faster than others that there is a very strong commercial reason. For example, you may wish to pass a board resolution to “pay XZY Ltd as it maximises the interest of creditors to pay XZY Ltd as they’re our only supplier of widgets, by paying them we keep the factory going and generate debtors”. Consider rescue and insolvency advice at the same time

Ensure that you regularly consider of the company’s solvency, you may ask for a time to pay PAYE or VAT along with asking the bank for support, introduction of new capital. If all of this is not sufficient to prevent the company running out of cash, then more radical solutions must be considered, such as administration and liquidation, company voluntary arrangement or receivership.

This is a path that requires professional advice, common sense and full discussion by the board and proper documentation of decisions to continue trading and to pay suppliers taken at board and management levels.

Man with umbrella

What Is A Winding Up Petition By HMRC or Other Creditor

A winding up petition is a legal notice put forward to the court by a creditor. The creditor petitions to the court if they are owed more than £750 and it has not been paid for more than 21 days. The application, in effect, asks the court to liquidate the company as they believe the company is insolvent.

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What Is A Winding Up Petition By HMRC or Other Creditor
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Notice of Intention To Appoint Administrators

A notice of intention to appoint administrators is when the company files a document to the court to outline that it intends to go into administration if a solution cannot be found to its immediate financial problems. It can be used as part of the pre-pack administration process as well as used to restructure a failing business to avoid its liquidation.

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Notice of Intention To Appoint Administrators
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What Does Going Into Administration Mean?

Going into administration is when a company becomes insolvent and is put under the control of Licensed Insolvency Practitioners.  The directors and the secured lenders can appoint administrators through a court process in order to protect the company and their position as much as possible. Going Into Administration - A Simple Guide Administration is a very powerful process for gaining control when a company has serious cashflow problems, is insolvent and facing serious threats from creditors. The Court may appoint a licensed insolvency practitioner as administrator. This places a moratorium around the company and stops all legal actions.The administration must have a purpose and the Government encourages the use of company rescue mechanisms after administration. The 3 purposes (or objectives) of Administration Rescuing the company as a going concern. (Note: this purpose is to rescue the Company as opposed to rescuing the business undertaken by the Company.)Company rescue as a going concern – this is usually a  company voluntary arrangement. The company enters protective administration and is then restructured before entering into a CVA. The CVA would set out proposals for repayment of debts to secured, preferential and unsecured creditors. When the company has its CVA approved by creditors, then the administration process comes to an end after 28 days. Achieving a better result for the company's creditors This is as a whole than would be likely if the company was to be wound up (liquidation) See the differences between Administration and Liquidation.  This better result is usually obtained by selling the BUSINESS as a going concern to one or more buyers. The company and the debts are “left behind”. The better result may include securing transfer or employees under TUPE, as well as selling goodwill, intellectual property and assets. Controlling and then selling property/debtors. This is called realising assets. Then the administrator makes a distribution to one or more secured or preferential creditors, in order of creditors priority. Usually the business ceases trading and employees are made redundant.Only if the first two options are deemed unattainable, can the administrator use this third option.Under the administration option, it is possible for the company and its directors (or a creditor like the bank) to apply to the court to put the company into administration through a streamlined process.However, the law requires that any finance provider (like a bank or lender), with the appropriate security, is contacted and the aims of the administration be discussed and approved. The finance provider must have a fixed and floating charge (usually under a debenture) and the charge holder will need to give permission for the process to go ahead. Five days clear notice is required.  Be aware, though, that a secured lender can appoint administrators over a company without notice if it thinks its money is at risk.  So communication with the secured lender is essential.  

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What Does Going Into Administration Mean?

What is Receivership?

in What is …? What is receivership?

Understanding Receivership: Receivership, also known as administrative receivership, is a legally sanctioned procedure where an entity, typically a lender like a bank, appoints a receiver. The primary role of this receiver is to "receive" and liquidate the company's assets, if necessary, to repay the lender. This process is particularly beneficial to creditors as it aids in the recovery of defaulted funds, potentially preventing the company from facing liquidation The introduction of a receivership simplifies the lender's task of securing owed funds in cases of borrower default.Receivership should not be confused with administration and a receiver can only be appointed by a holder of a qualifying floating charge created before September 2003. Changes to this procedure were brought in by The Enterprise Act 2002 which promoted company rescue and saving struggling businesses. Why would a company go into receivership?The company requires finance for its activities and borrows from a bank (or other secured lender). In consideration for providing the loan, the bank requires security. Normally the company will sign a debenture with a fixed and floating charge. This offers the bank security over the assets of the company. If the terms of the agreement are breached or the company does not conform to the bank's wishes, the charge holder can:Appoint investigating accountants to ascertain how secure or not the bank's debt is and determine the best route forward (not always receivership). Demand formal repayment of the loans without notice. Appoint a receiver to administer and receive the company's assets.The receiver has a duty to collect the bank's debts only,they are not generally concerned with the other unsecured creditors or shareholders' exposure.Receivership - A typical appointment Having borrowed against a business plan that has not worked, a company finds that it is suffering cashflow problems. In an effort to survive, the company reports its problems to the bank and the bank asks for more information on the problems the company faces. Struggling with the problems of firefighting, the directors find it difficult to produce the information. Often the accountancy and reporting systems are not robust and a lot of time is needed to work out where the company is going, what the depth of the problems is and the necessary reporting to the bank is delayed.As time goes by, the company's overdraft is constantly at its limit, because monies don't come in fast enough from customers. Clearly this should set alarm bells ringing at the company - it most certainly does at the bank. They call this ceiling borrowing, and take it as a sign that the directors are losing control.  When this happens the bank will review the account and will typically take some or all of the following steps: What the Bank will doThe bank will ask for a reduction in its exposure. It will ask for increased security from the directors or shareholders. Usually this takes the form of personal guarantees to support the security that the company has given through the debenture. It may ask for new capital to be introduced by the shareholders. Problem is though, occasionally, this only has the effect of reducing the bank exposure as the bank takes this cash to reduce the borrowing. It can ask for a new business plan from the directors, along with regular reporting. It may ask for the company to consider receivables finance (factoring) to remove its borrowing and move to a factor. Often the bank's own factoring company. If they are still not satisfied that the directors are in control and if the bank is concerned about its exposure it will ask for investigating accountants (or reporting accountants) to look at the business. Normally this is a large firm of accountants who send an insolvency practitioner (IP) into the business to ascertain:Is the business viable? Is the company stable? Does it have a long term future if the present difficulties can be overcome? Is the bank's exposure sufficiently covered in the event of a failure? In this report the IP calculates what the assets of the business are worth on a going-concern basis and in a forced sale scenario (or closure basis). Investigating accountants often recommend that the bank sticks with the business, but that the bank should limit any further borrowing to the fully secured variety - in other words the directors must secure it personally against property for example. If the IP thinks that the company is in serious risk of failure and that the banks may lose money in that event, he/she will usually recommend to the bank that they appoint a receiver or administrator. Usually the bank (bizarrely) requires the directors to "request the bank to appoint a receiver". This is face-saving, and designed to deflect criticism from the bank to the directors.At Company Rescue, we believe that it is wrong that the insolvency practitioner that carries out the investigation could also be the receiver - We think it is essential that his/her role as investigating accountant is limited to just that. However, fortunately most banks now agree that this is not a good approach. Once they are appointed what is the receiver's role and powers?A receiver will quickly ascertain what the prospects for business are and decide whether to sell some or all of the assets, the business as a whole, or to continue to trade whilst a better deal can be achieved. Because of the rules and case law, he may wish to get rid of the assets and staff as soon as possible. (They will have to adopt employment contracts 14 days after the appointment). They may remove directors and employees without impunity. They ultimately decides the way forward and will (often) not take advice from the directors. They must pay the preferential debts (employees claims for arrears of pay and holiday pay) first from any floating charge collections. If a deal is to be done with directors the receiver must first advertise the business and its assets for sale. They must conform to the tight rules and regulations governing receivership and report to the DBEIS. A receiver must investigate the conduct of the directors of the business and file a report with the DBEIS.Disadvantages of Receivership The company is rarely saved in its existing form. Its assets will be subject to "meltdown" ( most people know that in receivership or liquidation assets are sold at a knock down price), often jobs and economic activity are lost.The directors will typically lose their employment and any monies the company is due to them, and the company may cease to trade. In addition the director's conduct is investigated.From the creditors' perspective, it is unlikely that any unsecured creditors will receive any of their money back and often they lose a valuable customer. Clearly the cost of receivership can be very high and the bank has to underwrite the receiver's costs. Advantages of Receivership The bank can take control where directors have maybe lost control. The receiver also has power to act to save the business quickly. The bank can ensure that its exposure is (at least) not increased and hopefully recover all of its money. For directors, the advantages are that it mitigates the risk of wrongful trading and may crystallise a very difficult position allowing them to get on with their lives.Preferential creditors may see their debts repaid by the receiver.Still got questions? Click here for Receivership FAQs. If there are still unanswered questions contact us by email or call 08009700539.If your business is in trouble and the relationship with the bank is breaking down, we suggest that you look carefully at the guides in this site. Receivership may be an option. Work out the viability of the business - can you trim costs? Work out the problems, set out the position and have a meeting of directors. Decide if the business can continue but needs to be restructured or if just not viable then consider administration or if the company's lenders have a debenture pre-dating 2003 then receivership.Please call us on 020 7887 2667 (London) or 08009700539 to talk to an expert turnaround advisor if you would like to talk through your company's options.

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What is Receivership?

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