Purpose
The purpose is to prevent a creditor obtaining an improper advantage over other creditors of a company at a time when that company is insolvent.
Who may bring a claim?
Only a liquidator or an administrator may make an application to court to challenge a preference (s.239(1)).
What is a preference? (s.239(4))
A company gives a preference to a person if:
- that person is a creditor of the company (or a surety or guarantor of any of the company’s debts or liabilities); and
- the company does anything or suffers (i.e. allows) anything to be done which has the effect of putting that person in a better position in the event of the company going into insolvent liquidation than he/she would otherwise have been in.
An example of a preference would be paying an unsecured creditor in priority to other creditors.
When and how can the preference be avoided?
The preference is voidable if:
- It was given within the ‘relevant time’ (s.239(2)) – in the 6 months preceding the ‘onset of insolvency’ (s.240(1)(b)), being the commencement of the relevant insolvency procedure (s.240(3)).
The relevant time is extended to 2 years for preferences to connected persons and associates (s.240(1)(a)). (See ss.249 and 435 for definitions of ‘connected persons’ and ‘associates’).
- It is proved that the company was insolvent (on either a cash flow or balance sheet basis) at the time of the transaction or became so as a result of it (s.240(2)).
In contrast to transactions at an undervalue, there is no statutory presumption of insolvency where the preference is given to a person who is connected with the company.
- It is proved that the company was ‘influenced … by a desire’ to prefer the creditor (s.239(5)). This is a subjective test. The company must have positively wished to put the party in a better position (see Re MC Bacon Ltd example below).
If the preference is given to a connected person or associate, there is a rebuttable presumption that the company was influenced by the desire to prefer the creditor (s.239(6)). This shifts the burden of proof from the liquidator or administrator to the preferred person to rebut the statutory presumption. (See ss.249 and 435 for ‘connected persons’ and ‘associates’).
Defence
The defence available is an absence of the desire to prefer required by s. 239(5).
In Re MC Bacon Ltd, the company granted fixed and floating charges to its bank to secure an existing overdraft, as a condition of the bank not calling in the overdraft, at a time when it was insolvent.
It was held that it is not necessary to prove an intention to prefer (which is objective), but a desire to prefer (which is subjective). On the facts, the security could not be challenged as a preference because the directors, in granting the security, had not been influenced by a desire to prefer the bank, but only by the desire to continue trading and to avoid the calling in of the company’s overdraft (i.e. the security was granted as a result of genuine commercial pressure exerted by the lender and the presence of such pressure negated any desire on the debtor’s part to prefer the lender).
Sanction
The court has a discretion to make an order to restore the position as if the company had not given the preference (s.239(3)). S.241(1) provides a nonexhaustive list of the types of restoration order that the court may make.
Ss.241(2) and 241(2A) apply to both preferences and transactions at an undervalue.