How to Challenge a Preferential Payment to a Creditor

How to Challenge a Preferential Payment to a Creditor

When a company enters insolvency, the transactions it carried out before liquidation or administration may be reviewed by an insolvency practitioner. This is because certain payments made before insolvency can unfairly place one creditor in a better position than others.

A preferential payment occurs where a company pays a creditor, guarantor or another party in a way that improves their position compared with other creditors if the company later enters insolvency.

Where a payment is considered to be a preference, an insolvency office-holder may be able to challenge the transaction and seek repayment for the benefit of the company’s creditors.

Understanding when a preferential payment can be challenged and what defences may be available is important for directors, creditors and insolvency practitioners. 

What Is a Preferential Payment?

A preferential payment is a payment or transaction made by a company before insolvency that gives one creditor an advantage over other creditors.

The purpose of insolvency law is to ensure that creditors are treated fairly when a company cannot pay all of its debts.

A payment may be considered preferential where:

• A creditor receives payment ahead of others
• The payment improves the creditor’s position during insolvency
• The company was insolvent at the time or became insolvent because of the transaction
• The company was influenced by a desire to favour that creditor

Examples of payments that may be reviewed include:

• Paying a director’s personal guarantee
• Repaying money owed to a connected party
• Paying one supplier while leaving other creditors unpaid
• Providing additional security to a creditor shortly before insolvency

The circumstances surrounding the payment will determine whether it can be challenged.

Who Can Challenge a Preferential Payment?

A preferential payment can usually only be challenged by an insolvency office-holder.

This includes:

• A liquidator • An administrator • Another appointed insolvency practitioner with the relevant authority

Individual creditors cannot usually bring a preference claim themselves. However, they may raise concerns with the insolvency practitioner if they believe a transaction unfairly benefited another creditor.

The insolvency practitioner’s role is to investigate the company’s affairs and recover assets where appropriate for the benefit of creditors as a whole.

When Can a Preferential Payment Be Challenged?

There are specific legal requirements that must be met before a preferential payment can be challenged.

The insolvency practitioner will usually need to show that:

• A payment or transaction took place within the relevant time period before insolvency • The company was unable to pay its debts or became unable to pay them because of the transaction • The company had a desire to put that creditor in a better position

The timing of the payment is important because insolvency law sets limits on how far back transactions can be reviewed.

What Is the Relevant Time Period for a Preference Claim?

The period in which a transaction can be challenged depends on who received the payment.

Generally:

• Payments to ordinary creditors may be challenged if made within six months before insolvency
• Payments involving connected persons, such as directors or related parties, may be challenged if made within two years before insolvency

Connected parties are treated differently because the law recognises that there may be a greater risk of unfair preference where personal relationships exist.

What Does a Liquidator Need to Prove?

To successfully challenge a preferential payment, the liquidator or administrator must establish certain legal requirements.

These usually include:

The Creditor Was Put in a Better Position

The payment must have improved the recipient’s position compared with what they would have received if the company had entered insolvency without making the payment.

For example, paying one unsecured creditor in full shortly before liquidation may reduce the funds available for other creditors.

The Company Was Insolvent

The company must have been insolvent at the time of the payment or become insolvent because of the transaction.

Evidence may include:

• Financial record
• Bank statements
• Accounts information
• Outstanding creditor demands
• Cash flow information 

There Was a Desire to Prefer the Creditor

One of the most important elements is whether the company was influenced by a desire to favour that particular creditor.

Simply paying a creditor before insolvency does not automatically mean a preference occurred.

The circumstances behind the decision will be considered, including why the payment was made and what motivated the company.

How Does a Preferential Payment Claim Begin?

A preference claim usually begins after a company enters formal insolvency proceedings.

The insolvency practitioner will review the company’s financial history and examine transactions made before insolvency.

The investigation may involve:

• Reviewing company accounts
• Examining bank transactions
• Looking at payments made to creditors • Considering relationships between the company and recipients • Assessing decisions made by directors

If a potentially preferential payment is identified, the insolvency practitioner may contact the recipient and seek repayment.

Can a Preferential Payment Be Challenged in Court?

Yes.

If the recipient does not agree to repay the money voluntarily, the insolvency practitioner may apply to the court for an order.

The court will consider:

• Whether the legal requirements for a preference have been m
• The evidence provided by both parties
• The circumstances surrounding the payment

If the claim is successful, the court may order that the payment is restored to the company’s insolvency estate.

What Happens If a Preferential Payment Claim Succeeds?

If the court decides that a preferential payment occurred, it may order the recipient to repay the value of the payment.

The recovered funds can then be used as part of the company’s assets and distributed to creditors according to the insolvency process.

The purpose is not to punish the recipient but to restore fairness between creditors.

Can a Preferential Payment Claim Be Defended?

Yes.

A person or company accused of receiving a preferential payment may have grounds to challenge the claim.

Possible arguments may include:

• The payment was made for genuine commercial reasons
• There was no intention to favour the creditor
• The company was not insolvent at the time
• The transaction took place outside the relevant time period • The payment was made in exchange for genuine goods or services

The success of any defence will depend on the evidence available and the circumstances of the transaction.

What Is a Desire to Prefer?

A desire to prefer means that the company was influenced by the intention to improve a particular creditor’s position over others.

This does not necessarily mean the company acted dishonestly.

For example, a company may make a payment because it wants to maintain an important supplier relationship. The reason behind the payment will need to be considered carefully.

The court will look at the facts surrounding the transaction to determine whether the company intended to favour that creditor.

Can Payments to Directors Be Challenged?

Yes.

Payments made to directors, shareholders or connected parties may receive particular scrutiny during insolvency investigations.

This is because payments involving connected persons may raise concerns about whether other creditors were unfairly disadvantaged.

Examples may include:

• Repayment of director loans
• Payments to family members
• Transfers involving associated companies

Directors should seek advice before making payments when a company is experiencing financial difficulties.

Do You Need a Solicitor for a Preferential Payment Dispute?

Preferential payment claims can involve complex insolvency law and detailed financial evidence.

A solicitor can help you:

• Assess whether a payment can legally be challenged
• Review evidence relating to the transaction
• Advise on possible defences
• Negotiate with an insolvency practitioner • Represent you in court proceedings if required

Obtaining legal advice at an early stage can help protect your position and ensure the correct approach is taken.

Frequently Asked Questions

What happens if a company pays one creditor before liquidation?

A payment to one creditor before liquidation may be reviewed to determine whether it was a preferential payment. If it unfairly improved that creditor’s position, it may be challenged.

Can a director be personally liable for a preferential payment?

A director may face scrutiny where they were involved in decisions that resulted in an unlawful preference, particularly where the payment involved a connected party.

Does a preferential payment require dishonesty?

No. A preference claim does not require proof of dishonesty. The key issue is whether the legal requirements for a preference have been met.

Can a creditor keep money received as a preferential payment?

If a court finds that the payment was a preference, the creditor may be required to repay the money or return the benefit received.

How far back can preferential payments be investigated?

The relevant period depends on the circumstances of the transaction and whether the recipient is a connected person.

Enquiries

If you have an enquiry relating to the above-mentioned subject please feel free to contact Dominic Levent Solicitors:

Phone Number: 0208 347 6640

Email: enquiries@dominiclevent.com