Asset Restructuring Example Of A Preference In Insolvency

This article is about an asset restructuring example of a preference in insolvency.

The effect of insolvency is to impose on a director the Creditor Duty; the need to have regard for the interests of creditors.

When a director needs to have regard for the interests of creditors it is crucial they have regard for the interests of all creditors not only those creditors they are closest to, such as themselves or their connected companies or their associates (defined in Section 435 of the Insolvency Act 1986).

In essence, a key director’s duty when a company is insolvent is to look to treat creditors of the same class equally. Creditors of a higher class such as secured creditors will have more rights to the assets than those of a lower class such as unsecured creditors.

What Is A Preference?

A preference is a transaction that puts a creditor into a better position than otherwise would not have happened had the relevant transaction not happened. By far the most common way to give a preference is by a payment from a company’s bank account to the creditor.

For a more detailed look at the criteria to assess whether a transaction is a preference have a look at our article What Is A Preference? which explains the effects of Section 239 of the Insolvency Act 1986.

To keep the example simple it assumes the only creditors are unsecured creditors.

The Preference Example

Two connected companies: Company A and Company B.

Company A is a creditor of Company B, being owed money by it. 

Company B has a remaining asset and it is insolvent, on the verge of going into an insolvency procedure such as liquidation because it cannot pay its debts to all of its creditors when they fall due. Instead of selling the asset and turning it into cash and then making a payment from Company B to Company A, Company B simply gives the asset to Company A and reduces the amount that Company B owes to Company A by the market value of the asset.

The transaction in question which is an offset, is a preference (subject to satisfaction of the criteria that apply for transactions to amount to a preference involving relevant time and the desire to prefer). 

Company A is put into a more advantageous position than the other creditors.

Directors when they have a company in a group that is in financial difficulty may overlook that there are other creditors who rank equally as unsecured creditors along with another of their group companies. Being focused on the justification for a preference transaction that the recipient that gets the benefit of the asset is owed money is not sufficient to escape the preference suggestion. 

When a company is going into liquidation you cannot pick and choose which creditors it pays.