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Understanding preference payments in liquidation and your duties as a director

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What happens if you make a preference payment when your company is insolvent?

If you make a preference payment, you could be severely reprimanded as this could worsen the financial position of creditors and it is in breach of your duties as a company director. If your business is insolvent and you pay off a debt of your choosing, this is a preference payment as there is a prescribed order that you must follow.

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Your legal responsibilities if your company becomes insolvent

Once you become aware that your company is insolvent, or there are warning signs that it is heading this way, it is your responsibility as director to ensure that you do all you can to maximise the financial return to your creditors, not engaging in any activity which threatens to worsen their position, and ensuring all creditors are treated the same. This means you are not allowed to use company funds to pay off one debt if you are unable to satisfy all your outstanding creditors; doing this is known as making a preference payment and is a serious breach of your duties as a company director.

It is important to note here that preferential payments are not limited to cash transactions but also include the transfer of company assets.

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Why might a preference payment be made?

If your company is insolvent, making a preferential payment will not improve your own company’s fortunes, however, you may be tempted to make such a payment out of a misguided sense of loyalty. You may feel an obligation to pay off creditors you have built up a good relationship with over the years, perhaps creditors who you may wish to use again in a future business endeavour, or you may wish to ensure “connected creditors” such as friends and family are not left out of pocket. You may also be tempted to prioritise paying off any borrowings which are secured with a personal guarantee in order to protect your own personal finances once your company enters liquidation. Although you may be able to justify these reasons to yourself, trying to convince an insolvency practitioner of the same will not be possible.

What are the repercussions of making a preference payment?

During the liquidation procedure, the appointed insolvency practitioner is bound to investigate the conduct of the company’s directors in the period leading up to insolvency and its subsequent entry into liquidation. As part of this process all transactions in and out of the business will be scrutinised and should a preference payment be suspected then you will be questioned about this. If it is judged that you deliberately aimed to create a preference by favouring particular creditors, then the courts will order that the recipient of the preference payment returns this money to the insolvent company.

How can I avoid making a preference payment?

If you believe your company has reached, or is approaching, insolvency, you should cease trading immediately and enlist the help of a licensed insolvency practitioner. Do not be tempted to sort the situation out on your own.

Although preference payments are illegal, there are occasions where you are permitted to pay certain creditors even when insolvent, so long as these payments are for the greater benefit of the company and its outstanding creditors. An example of this would be paying the electricity bill in order to allow the office to remain open which would facilitate the collection of debtor payments. However, the rules surrounding this are complex and you should always seek professional advice before making any payment if you are unsure whether it would be considered a preference.

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