"Keith, we look like going bust and we have lots of creditors. I am thinking of starting a new business and I need to protect some suppliers, can we pay my friend John his invoices before liquidation? That way he will supply "newco".
Every day in insolvency we hear questions like this one. By asking this type of question a director tends to indicate that deep down, he or she feels it is somehow wrong. Like the old saying, if it smells off, then it generally is off!
A straightforward plain English guide to s239 Insolvency Act 1986 - or s243 Unfair Preferences in Scotland.
A potential PREFERENCE occurs when a company pays a creditor(s) and by doing so makes that creditor "better off" than the majority of other creditors, before going into a formal insolvency like Administration or liquidation. However, the second important test is that there must be a "desire" to make that creditor better off. In the example question above my client wanted to make John better off.
This is an area of insolvency law that is commonly misunderstood, but can cause many problems for those who create the preference. If proven it can lead to action against the beneficiary, action against the directors, lifting of the veil of incorporation, personal liability and disqualification under other provisions of the insolvency legislation.
Please visit this page for a "case study" of Acme Nuts & Bolts Ltd http://www.companyrescue.co.uk/company-rescue/guides/preference-insolvency-act
Although a fictional case to protect our clients, it is very similar to many we have seen first hand.
How do we avoid creating a preference?
The safest route is to ensure that all creditors are treated "equally". If that is not possible then ensure that if one creditor is being paid faster than others that there is a very strong commercial reason. For example you may wish to pass a board resolution to"pay XZY Ltd as it maximises the interest of creditors to pay XZY Ltd as they're our only supplier of widgets, by paying them we keep the factory going and generate debtors, while we consider the rescue or insolvency options".
Ensure that you regularly consider of the company's solvency, you may ask for a time to pay PAYE or VAT along with asking the bank for support, introduction of new capital. If all of this is not sufficient to prevent the company running out of cash, then more radical solutions must be considered, such as administration and liquidation, company voluntary arrangement or receivership.
This is a path that requires professional advice, common sense and full discussion by the board and regular, proper documentation of decisions to continue trading and to pay suppliers taken at board and management levels.
If any doubt persists we strongly advise speaking to expert insolvency advisors.