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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.

Worried Director What Will Happen To Me After Liquidation?

in Company Liquidation What is …?

"A man in the pub said I cannot be a director of any other company if I liquidate my company. Is this true?"Actually, this statement is entirely false! Misconceptions like this frequently arise from individuals with limited understanding of the subject matter. Such misinformation can cause undue anxiety for directors considering liquidation, fearing it might personally affect them. Guess what? Listening to bar room experts, inexperienced accountants, or no insolvency specialist lawyers can stop decisions being made, this failure to make a decision is really what could land you in trouble. So how will liquidation affect me and how long does it take? Having a limited liability company means that the directors have little risk (or limited liability) if the company fails, as long as they have acted properly and acted in time. What is more, if as a director, you have been compliant and on the payroll for many years, you can actually claim redundancy from the government like any other employee. But, and it is a big but, if you fail to act in time, fail to act reasonably, fail to keep books and records, continue taking credit KNOWING that the company cannot possibly repay it, then you ARE at risk of personal financial loss or worse such as losing your house. So, act now and get help for your company and more importantly start reducing your own risks.Voluntary liquidation is the quickest most efficient way to deal with an insolvent company that has no future. As a director of an insolvent company, you are at risk if you do not act. This risk RISES the longer you don't act to put the company into liquidation.If you fail to act and the company is wound up by the creditors (compulsory liquidation) then the Official Receiver (OR) will be appointed to liquidate the business and he or she will investigate the activity of the directors and the business over the last 2-3 years. This is known as a conduct report on each director.  If the OR can prove there was wrongful trading where, for instance, you have taken credit from a supplier or took deposits from customers when you knew that it was highly unlikely that you could pay them back, then you could be made personally liable.This is known as the "lifting of the veil of incorporation" that protects directors under limited liability. If this happens then you could made liable for PAYE, VAT and creditors monies from the time that you should have known the company had no reasonable prospect of surviving the problems it faced.Additionally, the directors may face disqualification proceedings under the Company Directors Disqualification Act 1986 for up to 15 years, they can be fined and may face the loss of personal assets like your home, or even personal bankruptcy.Look, if you as directors have acted naively you may not know that you have broken these laws, but now you do know, it is vital to ensure that you protect yourself as a director by acting quickly to cease trading and put the company into voluntary liquidation; or consider a company voluntary arrangement if the company is VIABLE if the problems are solved. What is Creditors Voluntary Liquidation and what does it mean for me? In short, liquidation usually means, the company's trading stops and it's assets are turned into cash or "liquidated".All other possible liabilities, like employment liabilities, landlord's rent or payments to lease companies are stopped. It really is the end of the company, but the "business" may survive if a phoenix is organised. Liquidation is a powerful way to END creditor pressure and let you get on with your life. What if I have signed personal guarantees? If you have signed personal guarantees or indemnities to lenders, then the liquidation could lead to them being called in if the bank cannot get its money back from the company. There is little that can be done about that, but you should not delay decisions on liquidation to try and prevent a PG being called in: just think what ALL of the company's debts landing on your shoulders would do. Also it should be noted that HMRC now rank ahead of floating charge holders in any liquidation since December 2020.  Consequently, this may well mean that lenders that you have personally guaranteed will get less recovery hence exposing you more.All banks will agree a deal to repay the PG over time - provided you work with the bank to reduce their exposure.One great piece of FREE advice - always make sure that ALL tax returns, VAT returns and annual returns have been completed and sent in and that other "compliance" issues are dealt with wherever possible. These are important processes and will help protect you as individual directors. It shows that you have been acting properly.  I have heard about directors being able to claim redundancy in liquidation If you have been employed by the company and made payments via PAYE then you will be able to claim redundancy from the government and this is in fact a very simple process (20 minutes to fill out a form and we can help with that) so there is no need really to employ a third party to make a claim.  This process has been open to fraud so the HMRC are cracking down on operators that claim to be able to get money back when there is not enough "paperwork".  It isn't worth the risk.  If it sounds too good to be true then it probably is!You need to learn more about the options. This is clearly a general guide so, if you have any worries at all, please, just call us and we will talk you through the situation free and with expert guidance for your situation. Call one of our advisors or if you prefer, call our IPs (insolvency practitioners) now:Just one CALL will help relieve the stress and get you out of the mess.Why not call 08009700539 or 020 7887 2667 now?We could help you start the liquidation process today.(8.15am till 5.00pm; Out of hours call on 07833 240747, Wayne Harrison (IP)  or Eric Walls (IP) on 07787 278527)Finally, please remember this: NO BUSINESS is worth losing your health, relationships, marriages or your children over. Act properly, take advice, get the problem sorted and then get on with your life. In a little while the stress will go and you can focus on other things that are more important.Want more information on liquidation? Get our new free 2023 Experts Complete Guide to Creditors Voluntary Liquidation that covers Bounce Back LoansWe are experts in liquidation, voluntary liquidation, administration, pre-pack administration, business rescue, corporate rescue and company rescue, we can help solve your problems but only if you talk to us. Call 0800 9700539 for help.or email us your worries at 

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