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Directors Beware: The Preference Risk After The Pandemic

The UK Government’s new insolvency measures are broadly designed to provide businesses affected by the Covid-19 pandemic with breathing space and to enable them to keep trading during lockdown without having to enter a formal insolvency process or risk personal liability for their directors. The relaxation of the rules on wrongful trading is designed to provide directors with comfort that they will not face personal liability if they keep trading and the company subsequently ends up in an insolvency process. However, the new measures do not remove the possibility of personal liability entirely and many risks remain.

This article covers one of the key areas where directors may face personal liability if a company subsequently enters an insolvency process, namely in the case of preference claims.

English law recognizes distinct classes of creditors and when a company enters into an insolvency process, the law requires all creditors within each class to be treated equally. A preference arises where one particular creditor within a class is put in a more beneficial position to the detriment of the other creditors in the group, prior to an insolvency process. The “preference” does not necessarily need to result in a direct financial loss to the company and a transaction can be challenged merely for changing the classification of a creditor. If a preference has occurred, the officeholder can apply to the Court for an order to set aside the transaction.

A key point to consider when determining whether a preference has occurred is the question of when the transaction took place. One must also consider whether there was a desire to prefer that creditor by the director at the time the decision was made. If there was a desire to prefer and that was a motivating factor in the decision-making process, a preference will have been made (even though the desire to prefer may not have necessarily been the determining factor). A desire to prefer is assumed where the benefiting creditor is a connected party.

Preference claims catch a wide range of transactions including the early repayments of debts, the early repayment of directors’ loan accounts; granting new security to creditors without good reason and giving up assets.

One area requiring careful review by any officeholder is the repayment or reduction in a company’s liability to a creditor which is personally guaranteed by one or more directors. Not all such payments are preferences – and much will depend on the facts – but before making a payment directors should carefully consider what steps ought to be taken to mitigate the risk of a subsequent preference claim.

How we can help

Druces LLP regularly advises officeholders and directors on bringing and defending preference claims. We understand both sides and can advise directors on their duties, as well as assisting them in defending claims.

If you have any queries about any of the issues raised in this article, or require advice on directors’ duties or preference claims, please contact: