When a company is going through financial difficulties and there is a prospect of insolvency, it is vital to take care over actions taken. This includes who you decide to pay.
If you decide to clear debts with a particular creditor and paying that creditor puts them in a more beneficial position than the rest of your creditors, this action could be challenged by the liquidator or administrator in the event of insolvency proceedings following. This is known as a ‘preference’ under the Insolvency Act 1986.
In certain situations, a payment or transaction that is considered a preference can be set aside. If the payment was made within six months of the start of the insolvency proceedings, or within two years if the recipient of the payment was connected to the company, this will usually be the case.
If a company is unable to pay its debts due to a payment or transaction being made to a particular creditor, or if the company was encouraged by a desire to see the recipient of the payment in a more beneficial position, then the a payment or transaction may also be set aside.
Repaying a director’s loan can also be classed as a preference if the company enters into administration or liquidation.
How can a company avoid creating a preference?
The most straightforward way to avoid creating a preference is to ensure all creditors are treated equally. Where this is not possible, there will need to exist a proven and commercially feasible reason to have paid one creditor over another.
Such a reason could be that it would have been in the best interests of the other creditors for a particular supplier to be paid so that business could continue.
It is always a good idea to approach creditors like HMRC to request time to pay when it becomes apparent that a company is facing challenging financial times. Asking for support from the bank could also be considered by a liquidator or administrator as proactive attempts to improve a situation.
At the first inkling of financial difficulties within your company, you should always be upfront about what is going on. Discussing the matter in the first instance with your bookkeepers is always a good place to start. They can help you work out your position and make the best decisions that won’t land you in trouble down the line.