The risks associated with favouring creditors
What is a preference?
Under section 239 of the Insolvency Act 1986, any transaction which puts a creditor of an insolvent company at an advantage which they would not have enjoyed as a result of the liquidation process, is considered a preference.
When can a preference be set aside?
A preference which was made within the six months before a company started being wound up can be set aside by a court upon the application of a liquidator. It must be proved that the effect of the preference (to put one creditor in a better position) was intended. Additionally, the company must have been insolvent at the time the preference was made or this must have led to the insolvency. In the case of a preference which favoured anyone connected with the company, the limit is extended to two years prior to the onset of insolvency and there will be a presumption that a desire to prefer them existed.
What is a transaction at an undervalue?
Under section 238 of the Insolvency Act 1986, any transaction which appears to contain a significant imbalance (or where a business essentially gives away anything of value to another business or person) is considered to be a transaction at an undervalue.
When can a transaction at an undervalue be set aside?
A transaction at an undervalue which was made within the two years before a company started being wound up can be set aside by a court upon the application of a liquidator or administrator. The company must have been insolvent at the time the transaction at an undervalue occurred or this must have led to the insolvency - but if the transaction involved a person connected to the insolvent company then this will be assumed. However, if it can be proved that there were genuine commercial reasons for the transaction at the time it was made, it will not be set aside.
Potential breach of directors duties
Preferences or transactions at undervalue can be treated as a breach of duty by directors. A court can compel directors who have breached their duty in this way to personally repay any relevant money to the company in liquidation. Make sure that your insolvency is dealt with properly and that there is no favouritism connected to the process.