Preferences explained — section 239 Insolvency Act 1986

Section 239(4) IA 1986 defines a preference. A company gives a preference if it does anything (or suffers anything to be done) which has the effect of putting one of its creditors (or any surety or guarantor) in a position which, in the event of the company’s insolvent liquidation, will be better than the position the creditor would have been in if that thing had not been done. Common patterns:

• ›Payment to one unsecured creditor while others remain unpaid — the paid creditor recovers in full; others recover little or nothing.
• ›Granting security to an unsecured creditor — transforms unsecured claim into secured claim, advancing the creditor’s position in the statutory order.
• ›Repaying a director loan account — the director (as creditor) is paid; other creditors are not.
• ›Releasing a director from a personal guarantee — the lender’s right against the director is extinguished; in exchange the lender gets paid (or partially paid) by the company.
• ›Setting off accounts to favour one party — reducing a debt owed by the company in a way that benefits the connected creditor.

The Court will not find a preference unless the company was influenced by a ‘desire’ to put that creditor in a better position. The desire must have been one of the operative factors in the decision (not necessarily the only or main factor).

This is a subjective test — examining the state of mind of the directors at the time. Pressure from a creditor (e.g., supplier threatening to stop supply) often defeats the desire test — the directors paid because of commercial pressure, not because they wanted to put the creditor in a better position.

The leading authority on the desire test is Re MC Bacon Ltd [1990] BCLC 324. Millett J held the test requires positive influence by the desire to prefer — not merely knowledge that the recipient would be advantaged.

Section 239(6) IA 1986 creates a presumption for connected parties. Where the creditor is a ‘connected person’, the necessary desire is presumed unless the contrary is shown.

Connected persons under section 249 IA 1986 (and the wider definition in s.435) include:

• ›Directors and shadow directors.
• ›Associates of directors — typically spouses, civil partners, parents, siblings, children.
• ›Other companies in the same corporate group.
• ›Companies controlled by directors (whether by shareholding or otherwise).
• ›Business partners of directors.

The presumption is rebuttable — the burden shifts to the connected creditor (or the director who authorised the payment) to prove the payment was NOT influenced by desire to prefer. In practice, this is difficult — the connected party defence typically requires evidence of commercial pressure equivalent to that from third-party creditors.

Section 240 IA 1986 sets the relevant time for preferences. Two periods:

• ›6 months — for preferences to unconnected persons. Only preferences given in the 6 months before insolvency are voidable.
• ›2 years — for preferences to connected persons. Connected party preferences in the 2 years before insolvency are voidable.

The ‘onset of insolvency’ is typically the date of the section 100 decision procedure (for CVL) or the date of the administration appointment. Earlier transactions outside these windows are not voidable as preferences (though may be voidable under other provisions such as section 423 IA 1986 transactions defrauding creditors, where the lookback is unlimited but the threshold higher).

Section 240(2) IA 1986 requires the company to have been insolvent at the time of the preference (or to have become insolvent as a result). Insolvency tests:

• ›s.123(1)(e) IA 1986 — cashflow insolvency: the company cannot pay its debts as they fall due.
• ›s.123(2) IA 1986 — balance sheet insolvency: liabilities exceed assets.

Either test suffices. Both are commonly examined by the liquidator at the date of each potentially preferential transaction. Where the company appears solvent on a snapshot view but was clearly insolvent on a forward cashflow basis, cashflow insolvency typically applies.

Where a preference is established, three consequences:

• ›The Court can order the recipient to pay the value of the preference back to the company — s.241(1) IA 1986 grants wide remedial powers.
• ›The Court can order the recipient to transfer property received — where the preference involved transfer of property rather than payment.
• ›The Court can order any other appropriate remedy — including modifications of agreements, release of security, etc.

Recovery is from the recipient — but where the recipient was a director or connected company, the director who authorised the preference may also be personally liable under section 212 IA 1986 misfeasance. Two routes to recovery against the same individual.

Section 241(2) provides protection for innocent third parties — the Court won’t make orders prejudicing persons who acquired the benefit in good faith and for value without notice of the relevant circumstances.

1. Desire test not met

Most preference defences turn on the desire test. Where the payment was made under commercial pressure (supplier demanded payment to continue supplying; landlord threatened forfeiture; bank threatened to call facility), the desire to prefer is typically displaced by the desire to maintain trading operations. Particularly strong for unconnected creditors; for connected creditors the s.239(6) presumption must be rebutted with positive evidence.

2. Outside the lookback period

Transactions more than 6 months before insolvency (for unconnected creditors) or 2 years (for connected creditors) are outside section 239. Other provisions may apply (s.238, s.423) but s.239 doesn’t.

3. Company was solvent at the time

If the company was solvent both at the time of the transaction and immediately after, section 239 doesn’t apply. Cashflow and balance sheet tests examined at the relevant date.

4. The ‘preference’ didn’t actually prefer

Where the payment received was equal value (e.g., goods supplied of equivalent value; secured creditor’s existing security crystallised by payment), there’s no actual preferential effect. Useful for ongoing trading transactions where the recipient supplied goods or services worth the payment.

• ›In the period before insolvency — don’t favour connected parties. Director repayments, family supplier payments, group company transfers all attract scrutiny under the connected party presumption.
• ›Where commercial pressure forces specific payments — document the commercial reason. Demand letters, supply termination threats, lender pressure correspondence. The contemporaneous record defeats the desire test.
• ›Consider professional advice — an IP can identify in advance which planned transactions create preference risk. Better than the alternative of unwinding after the fact.
• ›Don’t try to ‘tidy up’ director loan accounts before insolvency — paying down DLA debt is the most common preference pattern and the most easily identified. The liquidator will see it and pursue recovery.

For transactions at undervalue (the companion antecedent transaction provision), see Transactions at undervalue. For voidable floating charges, see Voidable floating charges. For the broader director duties framework, see Director duties in financial difficulty. For wrongful trading exposure, see Wrongful trading.