What is a ‘Preference’ and how might it affect a creditor?

Insolvency

When an individual is made bankrupt, or a Company is placed into liquidation, the Trustee in Bankruptcy or Liquidator (“the Office Holder”) has the ability to pursue any transactions considered to be a “preference”. Preferences are payments made by an insolvent individual or company to one of its creditors within a specified time period before entering bankruptcy or liquidation. 

Whilst seemingly unfair, it is the creditor (who received the money) that would be pursued for the preference even if they were unaware of their debtor’s insolvency when the payment was made. That means that, if you received repayment of your debt from an individual who is now bankrupt or a company which has since entered liquidation, you could be ordered to repay that sum to the Office Holder and instead claim your debt as an unsecured creditor in the bankruptcy or liquidation.

What exactly constitutes a preference?

The law around preferences is set out in sections 239 (for companies) and 340 (for individuals) of the Insolvency Act 1986 (“the Act”). 

Preferences only relate to payments made by the bankrupt or company in liquidation to one of its creditors, sureties or guarantors for any of their debts or liabilities. The payment must also have been made with the intention to place that creditor in a better position than they would have otherwise been in, in the event of the debtor entering insolvency (“the Desire”). Where the creditor is an “associate” of the bankrupt/ company in liquidation, unless sufficient evidence is presented to the contrary, there is a presumption that the Desire was present.

What is an “Associate”?

An “associate” is defined in the section 435 of the Act. The following is not an exhaustive list but includes some of the most commonly encountered examples of an ‘associate’:

  • An individual’s spouse or civil partner
  • Relatives of the individual or relatives of the individual’s spouse or civil partner
  • Anyone with whom an individual is in partnership or anyone with whom that individual’s spouse/ civil partner is in partnership.
  • Anyone who you employ or anyone who you are employed by.
  • A company can be an associate of another company if it is controlled by the same person or if each company is controlled by ‘associates’.
  • A company can be an associate of an individual if that individual has control of it. 

Section 249 of the Act also sets out how a person could be “connected” with a company by:

  • being its director or shadow director
  • being an associate of the company’s director or shadow director
  • being an ‘associate’ of the company.

When must the payment have been made?

A payment must be made within the ‘relevant time’ to be a preference. The relevant time varies depending on whether the creditor is an “associate” of the bankrupt or liquidated company.

Where the creditor is NOT an associate or connected company, the payment will only be a ‘preference’ if it was made within 6 months prior to the date upon which the bankruptcy petition/ winding up petition was presented. 

Where the creditor IS an associate or connected company, a payment made within 2 years prior to the presentation of the bankruptcy petition/ winding up petition could be considered a preference.

However, the time will not be relevant unless it can be shown that the individual or company was insolvent (as defined in the Act) at the time of the payment, OR became insolvent as a result of the payment.

Summary of a preference

The law around preferences can be confusing and difficult to piece together. In summary the following must be present for a payment to be considered a preference:

  • It must have been made to the insolvent’s creditor/ surety/ guarantor
  • It must have been made with the requisite desire to place the recipient in a better position that they would otherwise be in on the debtor’s insolvency (although this is presumed if the payment was to an associate)
  • It must have been made either within the 6 months (if not an associate) or 2 years (if an associate) prior to the commencement of insolvency
  • The debtor must have been insolvent when the payment was made OR became insolvent as a result of the payment.
If you think you may have received a preference and need further advice regarding your position, please contact our insolvency team who will be happy to assist further.