Preference Payments and Wrongful Trading

Preference payments are payments made by an insolvent company to particular creditors (known as preferential creditors) and at the expense of other general creditors.

Wrongful Trading, as explained by the Insolvency Act 1986, is the situation whereby a company's directors have failed to act responsibly when they knew or ought to have known that a company was insolvent and unable to pay its debts. This article will explain both these concepts in more detail, and in the context of UK company law.

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What Are Preference Payments Exactly?

Preference payments occur when an insolvent company pays out money, or enters into agreements, which favour certain creditors over and above other creditors. An example of a preference payment would be; payments to directors via a director loan account over outstanding VAT debts

In order for a payment to be considered a preference payment, UK company law states that the following elements must be satisfied:

there must have been a debt owed by the company at the time of the transaction;

the creditor must have been someone who was favoured in the transaction;

The transaction happens within 2 years of insolvency

the company must have been granted some kind of benefit as a result of the transaction;

the transaction must have been entered into with the intention of favouring the creditor.

If the above is established, then the transaction is classified as a preference payment, and may be recalled by the liquidator and equally distributed creditors.

Wrongful Trading

Wrongful trading, as defined by section 214 of the Insolvency Act 1986, is a situation whereby a company's directors have failed to act responsibly when they knew or ought to have known that the company was insolvent and/or unable to pay its debts.

If a company is deemed to have been trading wrongfully, then the court may require the directors to personally contribute to the company's assets with an amount that is sufficient to cover the liabilities. When considering whether a director has been wrongfully trading, the court will look to the directors’ knowledge, their actions, and the level of their skill at the time the offence was committed.

Furthermore, wrongful trading may lead to the director being disqualified from acting as a director of a company for a period of up to 15 years, as deemed necessary by the court.

Conclusion

Under UK company law, preference payments and wrongful trading are both real risks that arise during periods of insolvency. Preference payments occur when an insolvent company makes payments to certain creditors which result in an unfair advantage to those creditors, while wrongful trading refers to a situation whereby a company’s directors have failed to act responsibly when they knew or ought to have known that a company was insolvent and unable to pay its debts. It is important that directors are aware of both of these areas of law in order to ensure their own and their company’s compliance.