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Preferences

Definition and Legal Requirement

A Preference is when a company affords special treatment to a type of creditor, being at the detriment of other creditors forming the same group.

Once a company enters into Administration or Liquidation, the appointed Administrator or Liquidator is required by law to investigate whether any creditors have been preferred. This will be done by collating and analysing the company’s financial statements, books and records and bank statements.

For a Preference claim to be successful it will have to have been made within the “relevant time”.  The “relevant time” differs upon whether or not a person receiving the Preference is “connected” or “unconnected” with the company.

In the case of “unconnected” persons, the “relevant time” is 6 months leading up to the “onset of insolvency”. In the case of “connected” persons, the “relevant time” is 2 years leading up to the “onset of insolvency”.

Ramifications

When an Administrator or Liquidator establishes that a preference has been made there are a number of ramifications, the most important being:

  • Details of the preference will form part of the Directors’ conduct report that the Administrator or Liquidator is required to submit to the Insolvency Service. This will have some impact upon the Insolvency Service’s decision to commence disqualification proceedings;
  • Compensation may be sought against the Directors, irrespective as to whether or not they were the direct recipients of the Preference; and
  • Recovery may be sought from party or parties that received the benefit.

Defence

The most important element to establishing a Preference is the fact that there was a desire to prefer. The desire has to be seen to be the motivational influence in making the Preference.

If it can be demonstrated that there was no intention to desire the making of a Preference, the claim may be defeated. However, there will be a rebuttable presumption that there was such an intention if the Preference was made to someone “connected” with the company.

Additionally, it has to be shown that the effect of the transaction was betterment. There will be defence to a Preference claim if it can be shown that the effect of the transaction did not improve the recipients position.

FAQs

What Are Examples of Preferences?

There are numerous payments that can be made that could potentially qualify as being a Preference. These include such things as repaying a loan where Directors have personal guarantees, settling certain creditors accounts in full and making additional payments to a pension scheme.

How is the “Relevant Time” Calculated When Investigating Whether or Not Transactions Can be Considered Preferences?

The “relevant time” is calculated from working backward from the “onset of insolvency”.  For “connected” and “unconnected” parties, it is 2 years and 6 months up to the “onset of Insolvency”, respectively. However, a time is not a “relevant time” unless the company was at the moment the Preference was given, unable to pay its debts as they fell due or became so as a consequence of the transaction.

How is the “Onset of Insolvency” Determined?

There are various scenarios which determine the “onset of insolvency”. These are broadly to do with when insolvency proceedings are commenced. Commencement would be the date that a Winding Up Petition was presented against a company, or when the Notice of Intention to Appoint and Administrator was filed, or when the Directors of a company resolve to place a company into Creditors Voluntary Liquidation.

Who is A “Connected Party”?

A “connected party” is either a Director or a Shadow Director or an “associate” of a Director or Shadow Director.  An “associate” covers a wide and varied selection of relationships including spouse, civil partner, partnership and trustee.

What Are the Defences to a Preference Claim?

There are various lines of defence available to Preference claims.  For example it may be demonstrated that the asserted Preference was not influence by a desire to prefer. Alternatively, that the company was not insolvent at the time or as a result of the benefit. Whilst on the face of it a transaction may be initially perceived as a Preference, the recipient did not actually receive any betterment.

What is a Rebuttable Presumption?

There is an automatic presumption of a desire to prefer a “connected” party. This means that it will be automatically taken that the motivation influence was there in cases of a potential Preference transaction to a person “connected” to the company. However, this presumption is not definitive and is rebuttable, i.e. it can be overturned provided it can be shown that no such desire existed.

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