Company directors must be vigilant about the implications of insolvency, particularly when it comes to preference payments. Understanding what constitutes a preference and the potential consequences is essential for maintaining legal and ethical standards. Here’s a guide on what directors should know about insolvency preference payments.
What is a ‘Preferential Payment’?
A ‘preference’ occurs when a company facing insolvency puts a specific creditor or group of creditors in a better position than others. This can involve making payments or engaging in transactions, such as granting a charge over assets. Directors should be aware that facilitating a preference can lead to personal liability and, in severe cases, disqualification for up to 15 years.
What is Classed as a Preference Payment?
A payment or transaction could be classified as a preference if:
- It was made when the company was unable to pay its debts, within the meaning of Section 123 of the Insolvency Act 1986.
- The company becomes unable to pay its debts as a consequence of the preference.
- It occurs within the relevant time period before the onset of insolvency. This is up to two years for transactions involving a connected party, and six months for unconnected parties.
The company must also have ‘desired’ to prefer the creditor, meaning there was an intention to put that creditor in a better position. There is an automatic assumption of this desire if the preference was made to a connected party.
Examples of Preferences
Preference payments can take various forms, including:
- Repaying a loan to someone connected to the company, such as a relative.
- Repaying a debt that is personally guaranteed by the director.
- Paying a creditor to encourage an ongoing business relationship after the insolvency of the existing company.
- Creating a charge over assets, putting that creditor in a better position.
Consequences of Preference Payments
If the company enters an insolvency process like administration or liquidation, the appointed Insolvency Practitioner (IP) must investigate the company’s affairs and the conduct of the directors. They will look for any wrongful actions and identify any preference transactions made during the relevant time period.
If a preference is identified, the IP will aim to restore the situation to what it would have been if the preference had not occurred. This could involve recovering funds from the recipient or, if that’s not possible, seeking compensation from the director. Any charges over assets created as a preference might also be voided. Additionally, the IP must submit a Director Conduct Report to the Insolvency Service, which could lead to the director’s disqualification for up to 15 years.
What Should Directors Consider?
Directors must act responsibly, especially if the company is insolvent or potentially facing insolvency. Directors have a duty to treat all creditors equally, and avoid actions that could worsen a creditor’s position.
However, in some cases, it might be necessary to prioritise one creditor over another if their continued supply is crucial for the company’s operation. For instance, paying an electricity supplier to ensure the warehouse remains operational can help the company fulfil orders and generate additional income.
In such scenarios, directors should carefully document their decision-making process in the company records.
Seeking Advice
Insolvency and preferential payments are complex areas. Directors who are uncertain about any aspect should seek professional advice. If your company is struggling financially, it is crucial to contact an expert for help.
Navigating the complexities of insolvency and preference payments requires diligence and informed decision-making. By understanding these key aspects, directors can better manage their responsibilities and safeguard their company’s and their own financial integrity.
For queries regarding preference payments, reach out to our team now at info@iladvisory.co.uk