PREFERENCES

PART 2

February 2010

PREFERENCES

31.4A.25 Preferences - introduction

The provisions of the Act relating to preferences [note 1] [note 2] allow the office-holder to challenge the doing by a company or individual (or the suffering of anything by a company or individual) of an act which has the effect of putting a creditor (or guarantor) in a position which, in the event of the company going into insolvent liquidation or the individual entering into bankruptcy, will be better than the position he/she would have been in if that act had not been carried out.  Examples of the types of events that may constitute the giving of a preference are given in paragraph 31.4A.37.

The ability of the liquidator or trustee to challenge such transactions is subject to time limits (see paragraph 31.4A.35), the financial position of the company/debtor at the time of the transaction (see paragraph 31.4A.36), the relationship between the company/individual and the beneficiary of the transaction (see paragraph 31.4A.30) and the purpose of the transaction (see paragraph 31.4A.28). 

 

31.4A.26 Realising preferences

(Amended August 2014)

As explained in detail in Part 1 of this chapter, all antecedent recoveries are handled by The Service’s antecedent recovery contractor (see paragraph 31.4A.5). 

The following are the areas on which the official receiver should, ideally, obtain information before instructing the contractor and include on the ‘details of conduct/transaction’ section of the ARIA form (see paragraph 31.4A.9):

  • Any connection between the beneficiary and the insolvent.
  • The date of insolvency (as opposed to the date of the order)
  • Details of the payment that constitutes the preference.
  • The value of any assets transferred.
  • The sum of monies owed to the beneficiary.
  • Evidence of the desire to prefer.
  • The amount of monies owed to other creditors at the date of the transaction.
  • Any explanations given by the bankrupt or the insolvent for the transaction.
  • Evidence of the asset position of the beneficiary.
  • Details of any of the insolvent’s property charged to the beneficiary

 

31.4A.27 Deleted 

 

31.4A.28 Desire to prefer

The key point so far as regards deciding whether a preference has taken place is to decide whether or not the debtor was influenced by a desire to put the creditor in a better position (desire to prefer) than they would otherwise have been as a consequence of an insolvency event [note 3] [note 4].

The debtor must have been influenced by a desire to prefer, but this need not have been the dominant intention.  In other words, for a preference to be successfully challenged, the desire to prefer the creditor must have been part of the decision to enter into the transaction, but it need not have been the only factor nor, even, the factor that tipped the scales in favour of entering into the transaction.

Desire can be inferred from the circumstances of the case.  It has been held by the court that there was no desire to prefer when the company granted its bank a debenture over its assets and therefore there was no preference. [note 5].

Just because the creditor gains an advantage does not, of itself, mean that the debtor had a desire to prefer that creditor.  It would still be incumbent upon the office-holder to prove that the desire to prefer was actually a motivating factor [note 6].

 

31.4A.29 When must the desire to prefer exist?

(Amended November 2011)

The desire to prefer must exist at the date that the decision was made to make the payment that constitutes the preference, rather than that date that the payment was actually made [note7]. 

This might be important where the desire to prefer was present when the decision to make the payment was made, but was not present when the payment was made (if, for example, a friendship had broken down).

 

31.4A.30 Desire to prefer – connected party or associate

Where the person who benefitted from the preference is a connected party (see paragraph 31.4A.110) or an associate (see paragraph 31.4A.111), then it is presumed (unless the contrary can be shown) that the debtor was influenced by a desire to prefer [note 8] [note 9].

 

31.4A.31 Desire to prefer – companies

A company itself cannot be said to have desire, and any desire in the “mind” of the company must, of course, be formed in the mind(s) of those human beings controlling the company – e.g., the directors [note 10].  In order to successfully challenge a preference, the official receiver, as office holder, would need to show that the decision to prefer arose from a proper decision by those controlling the company – i.e., those with the controlling “mind” of the company (see paragraph 31.4A.115). 

Commonly in cases dealt with by the official receiver, the company has a small number of directors and, in these cases, identifying the controlling mind would be a relatively simple matter.  For the vast majority of these cases, the person(s) causing the company to undertake the transaction will be the sole director or the directors as a group and, therefore, there should be no difficulty in showing that they were acting on behalf of the company, and had authority to do so [note 11].

Where an employee, other than a director, took the decision to effect the transaction, it will be necessary to show that he/she had appropriate direct authority (a “blanket” authority, as it were) to act on behalf of the company – to be the “mind” of the company.  The motivation of the person with authority needs to be considered. [note 12].

 

31.4A.32 Transactions not normally viewed as preferences if desire to prefer not a motivating factor

As explained in paragraph 31.4A.28, a key feature of a preference is the desire on the part of the debtor to put the beneficiary of the transaction in a better position  in any subsequent liquidation or bankruptcy then they would have been had the transaction not taken place.

Simply because the creditor gains an advantage from the transaction does not, of itself, mean that the debtor had a desire to prefer that creditor.  It would still be incumbent upon the office-holder to prove that the desire to prefer was actually a motivating factor. 

An exception to this is where the transaction favours a person connected to or associated with the insolvent (see paragraphs 31.4A.110 and 31.4A.111) – in which case the desire to prefer is presumed unless the contrary can be shown (see paragraph 31.4A.30)

 

31.4A.33 Improvement in position

As outlined in paragraph 31.4A.28, one of the key features of a preference is that there must have been a desire to improve the position of the creditor.  The Act is silent on the measurement to be applied to assess the improvement.  Whilst it is not conclusive the case law on the subject has generally held that the improvement is to be measured against a hypothetical winding up or bankruptcy made immediately after the transaction rather than the date of actual insolvent liquidation or bankruptcy. [note 13].

 

31.4A.34 Relevant time

For a preference to be successfully challenged, it must have taken place at a certain time (see paragraph 31.4A.35) and under a particular financial position (see paragraph 31.4A.36).

 

31.4A.35 Time period

In a compulsory liquidation the transaction must have been entered into within six months of the “onset of insolvency” (for a compulsory liquidation) [note 14] or the presentation of the petition (bankruptcy cases) [note 15].  The “onset of insolvency” is the date of the presentation of the petition [note 16], unless the liquidation follows administration – in which case the “onset of insolvency” is the date of the making of the administration order [note 16a].

Where the beneficiary of the preference is a connected party (see paragraph 31.4A.110), or an associate (see paragraph 31.4A.111), the time period is extended to two years prior to the onset of insolvency or the presentation of the bankruptcy petition, as the case may be [note 17] [note 18].

 

31.4A.36 Time period – financial position

In addition to the time limits detailed in paragraph 31.4A.35, it is also necessary, for companies, to show that the company was unable to pay its debts at the time of the transaction (see paragraph 31.4A.108), or became unable to pay its debts as a result of the transaction [note 19].

So far as bankruptcies are concerned, it is necessary to show that the debtor was insolvent at the time of the transaction (see paragraph 31.4A.109) or became insolvent as a consequence of the transaction [note 20].

 

31.4A.37 Types of transactions that may be viewed as preferences

The repayment (or part-repayment) of a debt is the most likely example of a transaction that may be viewed as a preference.  Other examples would be the repayment of a guaranteed loan (see paragraph 31.4A.44), the granting of a charge or the return of goods obtained on credit. 

 

31.4A.38 Repayment of directors’ loan accounts

So far as company liquidations are concerned, one of the more common examples of a preference would be in respect of a director causing a company to repay an outstanding loan account owed to one or more of the directors.

 

31.4A.39 Payments to creditors in relation to a court order

Simply because a payment to a creditor is in respect of an order of court does not prevent that payment being challenged as a preference where, otherwise, it would be open to challenge - e.g. if a creditor had obtained a court judgement, payment of that debt could still constitute a preference [note 21].  It would, though, still be necessary to show that all other features of a preference were present in the transaction for a successful recovery.

 

31.4A.40 Payment under an existing obligation

Simply because a payment is given by a debtor under an existing obligation (such as a pre-agreed repayment plan) does not mean that it is not a preference.  The relevant date for deciding whether a preference has taken place is the date of the payment and not the date that the decision was taken to make the payment [note 22].

Conversely, the date of the desire to prefer (see paragraph 31.4A.28) is the date of the decision to make the payment, whereas the date to decide whether a preference has taken place is the date of the payment (see paragraph 31.4A.29).

 

31.4A.41 Delay in payment of new debt

Where there has been a delay in payment between the debt being incurred and the payment being made, this may constitute a preference as the supplier has, in the period between supply and payment, become a creditor.  It has been held that this circumstance should not automatically be viewed as a being a preference without looking at the reasons behind the delay – for example, the person with authority to make the payment may have been unavailable during the relevant period [note 23].

 

31.4A.42 Return of goods – retention of title

Where goods supplied on credit are returned to a supplier, this would normally constitute a preference (assuming all the other features were present) as those goods would otherwise be available to the estate for the benefit of the general body of creditors.  Where, however, those goods were supplied on a “retention of title” basis there cannot be a preference if they were returned as this would have happened as a result of the making of the winding up or bankruptcy order anyway.

On the other hand, a preference may have taken place where the returned goods that were subject to a retention of title clause were perishable or in some other way affected adversely by the passage of time (perhaps, seasonal goods).  The early return of the goods would have the effect of putting the creditor in a better position than they would have been if they had re-claimed the goods following the making of the winding-up or bankruptcy order – when the goods may have devalued.

 

31.4A.43 Giving up an asset to a creditor

A transaction does not have to involve a cash payment to be considered a preference.  For example, the giving up of an asset to a creditor can be considered to be a preference and the asset or, where this is not possible, the value of the asset transferred should be recovered.

 

31.4A.44 Guarantee debts

Where a debtor pays a debt which is guaranteed, it may be that the motivation was to put the guarantor in a better position, rather than the creditor.  In these circumstances the recovery action may be made against the creditor or guarantor. Recovery may be made against the creditor despite the debtor’s intention to prefer the guarantor, rather than the creditor. If an order is made against the creditor, the court may order that the guarantee be re-instated to prevent any injustice. Typically, this will be experienced in company liquidations where the director causes the company to pay or part-pay a debt that he/she has personally guaranteed.

Where a guarantee debt is secured on the insolvent’s property, there can be no preference if it is repaid as the debt would be repaid anyway under the security in the event of liquidation or bankruptcy (see paragraph 31.4A.47).  The repayment of any resultant shortfall would, of course, be a preference if all other features were present.

 

31.4A.45 Bank accounts

It is likely that a payment into a bank account will have been motivated by need to have a place to put the monies, rather than a desire to put the bank in a better position.  Different considerations would apply where the debt to the bank was covered by a guarantee (see paragraph 31.4A.44).

That said, in certain circumstances, it may be considered that the bank was a connected party (see paragraph 31.4A.110) and, therefore, it would be presumed that there was a desire to prefer (see paragraph 31.4A.28).  For a bank to be considered a connected party it will have to have been sufficiently involved to have been considered a shadow director [note 24] [note 25].  It should be noted that, whilst this is theoretically possible, it is improbable.

Payments into or out of a bank account may constitute a voidable transaction (see Part 5 of Chapter 31.4B).

 

31.4A.46 Creditor pressure

The most likely circumstance in which it may be viewed that a payment to a creditor is not a preference is where that payment was made as a result of pressure applied by the creditor.  The pressure may be threats to bring legal or recovery action, or threats to cease to supply the debtor – but, importantly, the threat(s) must be genuine.

 

31.4A.47 Payment to a secured creditor

Payment to a secured creditor would not normally be a preference as they would not be getting any more than would be available to them following the making of the winding-up or bankruptcy order.  Things would be different, though, were the payment over and above that which the secured creditor would have received in the liquidation or bankruptcy proceedings.

 

31.4A.48 The giving of a charge as a preference

Where there is the grant of a charge securing both pre-existing debts and new monies, the recoverable preference may be in respect of the amount of the charge that covers or seeks to cover the pre-existing debt only (see following paragraph) [note 26].

The granting of a floating charge may also be challenged where there has been no new benefit provided (see Part 3 of Chapter 31.4B).

 

31.4A.49 New consideration

Where the granting of a charge or other security to a creditor relates to new lending, there cannot be a preference as there is no overall change in the position of the debtor, even if the charge holder was an existing creditor of the debtor as payment is matched with consideration.

Similarly, where there has been new consideration in the form of goods or services supplied on credit there can be no preference.

Otherwise, suppliers or lenders may be discouraged from dealing with (and, possibly, helping to rescue) a struggling business.

 

31.4A.50 Right of set-off

Whilst a creditor reducing a debt under a right of set-off may, on the face of it, appear to be a preference, it is unlikely to be so as it is usually instigated by the creditor with no active involvement from the debtor [note 27].

A preference may have taken place where a debtor allows the creation of a right of set-off where none is allowed under law [note 28] or where the debtor gives his/her consent to the exercise of the right.

 

31.4A.51 Payment to a supplier in advance

Payment to a supplier in advance of the delivery of goods, or on “cash-on-delivery” terms cannot be a preference as that supplier was not a creditor in respect of that transaction.

 

31.4A.52 Payment of a debt for the provision of professional services

Where a debtor repays a debt to a professional advisor (perhaps, a solicitor or an accountant), it is possible that they were motivated by a desire to retain the services of that advisor at a difficult time, rather than to put them in a better position.  In that circumstance, it is unlikely to be a transaction open to challenge as a preference [note 29].

 

31.4A.53 Knowledge available to immediate and subsequent recipients of the property

The knowledge available to the recipient of the property is irrelevant so far as deciding whether or not a preference has taken place.  It matters not whether the recipient was aware of, or ignorant of, the financial position of the debtor, as the Act is concerned only with the motivations of the debtor (see paragraph 31.4A.28).  Even if the creditor has received the preference honestly, and in good faith, this will not alone prevent the recovery of the preference.

Where the property is transferred from the beneficiary of the transaction to a subsequent  party, the subsequent party is protected from being subject to an order restoring the position (see paragraph 31.4A.54) if the property was acquired in good faith and for value [note 30] [note 31].  Where the person who acquired the property had knowledge of the proceedings and surrounding circumstances, or is an associate (see paragraph 31.4A.111) or connected person (see paragraph 31.4A.110), then the onus to prove good faith is on that person and the property is capable of recovery in the usual way [note 32] [note 33].

 

31.4A.54 Remedies

The office holder (but, only the office-holder) has the power to apply to court for an order restoring the position where there is evidence that a company or individual has entered into a transaction resulting in a preference [note 34] [note 35].

The general principle is that, having decided that a preference has been made, the court shall make such order as it thinks fit for restoring the position to what it would have been if the company/individual had not entered into the transaction [note 36] [note 37].  In this regard, the court has wide discretion as to the order it may make restoring the position.  The Act provides a “menu” of possible remedies [note 38] [note 39] but the court is not limited to those options.  The order can be made against the recipient of the property or their successors in title (but see paragraph 31.4A.53 for an important defence for innocent third parties).

 

31.4A.55 Discretion of court not to make order

It has been held that the court has discretion to decline to make an order restoring the position (see paragraph 31.4A.54) where, for example, to do so would result in a hardship to the recipient [note 40]. 

 

31.4A.56 Effect of remedy on recipient of property

When deciding on the appropriate remedy to be ordered to restore the position of the estate, the court may also make an order providing for the extent to which the recipient of the property who repays the debt or returns the property may prove in the proceedings as a creditor [note 41] [note 42].

 

31.4A.57 Property status of a preference

The right of a liquidator to bring proceedings to set aside a preference does not form part of the company’s property and is, therefore, incapable of being charged or assigned [note 43] [note 44].

Whilst there have been no decided cases on this point in respect of bankruptcy, it is likely that the same principals might be applied to bankruptcy cases.

 

31.4A.58 Misfeasance – companies only

An action for misfeasance (see Part 4 of Chapter 31.4B) may only arise where there has been a financial loss to the company.  The giving of a preference does not result in any financial loss to the company – simply a change in the classification of the company’s creditors and cannot, therefore, be a matter of misfeasance [note 45].

 

[Back to Part 1 – Realisation of preferences and transactions at an undervalue] [On to Part 3 – Transactions at an undervalue]