Office holders Powers part 17

Section 239 of the Insolvency Act 1986 deals with preferences. The section applies in the same way as section 238 regarding transactions at undervalue which has been dealt with in previous articles.

There is however a difference between preferences and transactions at undervalue as regards the relevant time. As has been seen with the transactions at an undervalue, under section 240 the relevant time is two years ending with the onset of insolvency. The same applies in respect of preferences given to a person connected with the company (otherwise than by reason only of being its employee). (For relevant matters concerning onset of insolvency and connected persons, see Office holders Powers part 13.). For persons who are not connected the relevant time for preferences is 6 months ending with the onset of insolvency.

Preference is about preferring one person to another in discharging the debts of the company. If a company is on the brink of becoming insolvent, there may be some people who those in control of the company would rather see paid than others. If a company becomes insolvent then unsecured creditors are treated alike. If the ultimate dividend is 50p in the pound, and if your debt is £1 you get 50p, if your debt is £1,000,000 you get £500,000. However in the run-up to insolvency, there can be a deliberate decision on behalf of those running the company to ensure that some people are paid ahead of others. If that were permitted it effectively subverts the entire aim that assets should be shared rateably amongst the unsecured creditors (obviously after any secured creditors have realised their security).

Nor is this just a question of making payments to people who you know. Payments can also be made with other aims in mind. For example in private companies the directors will often have personally guaranteed the debts due to the bank. Ignoring for the moment the impact of any security the bank might hold, this could mean that the directors have a direct incentive to pay the bank ahead of anyone else, because that will avoid the bank and forcing the guarantee. Therefore sometimes payments made to the bank can be a deliberate preference because directors are trying to save themselves from any potential liability on the guarantee.

The test for what is a preference is set out in sections 239(4) and (5). Something can only be a preference if given in favour of a creditor or a surety or guarantor for any of the company's debts or liabilities. The preference can be the company doing something or suffering anything to be done which puts the person (the creditor surety etc) in a position which in the event of the company going into insolvent liquidation will be better than the position that person would have been in if the thing had not been done. (It could be a payment, it could be releasing something etc). However, there is no order to be made unless the company giving the preference was influenced in deciding to give the preference by a desire to improve the position of the person receiving the payment from that which would occur on insolvent litigation. That is something that the office holder has to prove on a balance of probabilities, except where the preference is given to a person connected with the company otherwise than by reason only of being its employee. In that situation it is presumed that the preference was influenced by a desire to improve their position on insolvent liquidation, unless the contrary is proved.

It is important to remember that the desire to provide a preference is a subjective matter. In other words was the company in entering into the transaction actually influenced by that desire? It need not be the sole or dominant desire of the company but has to have been a desire and the one of the matters causing the payment or other transaction complained of. Obviously with a company you consider the desire of the people who caused it to give the alleged preference. The court can draw inferences as to what was in the relevant mind. By contrast if matters were purely those arising from commercial considerations, there is no preference. Sometimes a company in trouble needs to make certain payments in the interests of the company (and ultimately possibly its creditors) with a view to its survival. It all depends upon the circumstances of the case.

If a preference did occur then the court has a discretion as to whether to make an order, and has the width of orders available of the type already considered on transactions at undervalue.