Distressed Companies and Decisions to Make a Preference
At what point in relation to a transaction by a distressed or insolvent company will it amount to a preference for the purposes of insolvency rules, such that it may be unwound? It can be a testing question for directors of companies who find themselves in financial difficulties and considering paying off a ‘preferred’ creditor.
Preferred creditors are often connected persons, such as family and friends or business associates and making payments to favour them above other creditors is likely to be unlawful. The Court of Appeal has handed down an important ruling that provides useful guidance where decisions are made ahead of completion of a transaction that potentially amounts to an unlawful preference.
What is a ‘preference’?
First, a reminder of what amounts to an unlawful preference: under section 239 Insolvency Act 1986, a preference occurs when an insolvent or distressed company pays a creditor with the effect of financially favouring that creditor above other creditors. The rules also apply to companies who become insolvent as a result of such a transaction.
The timing of a transaction preferring a creditor is important: for the purposes of s239, a transaction to a connected party must have arisen within two years of the transaction; and in other cases – six months.
Making a preference also breaches a director’s duties to protect the company’s creditors in order to minimise their losses (eg wrongful or fraudulent trading). Directors also have a duty to maximise the financial return to the company’s creditors collectively – a duty difficult to comply with if a preference is made.
What happened in this case?
The electrical retail giant Comet entered into a transaction repaying around £115.4m of intra-group debt – eight months before it went into administration. The liquidator claimed that this amounted to a preference within the meaning of s239 and should be unwound.
The repayment took place pursuant to a sale and purchase agreement (SPA) dated 9 November 2011 (the SPA anticipated the repayment). Importantly, the company itself was not a party to the SPA.
However, formal approval by Comet’s board of repayment of the debt did not take place until 3 February 2012. The transaction was completed on the same day. The question for the appeal court was whether that repayment amounted to an unlawful preference.
The timings were crucial to the outcome because, as Lewison LJ said in his ruling: “[The Act] is concerned with identifying the time at which a company actually gives a preference (rather than the time at which the company decides to give a preference).”
The CA ruled1 that no preference was made, finding that the company did not formally decide to repay the funds until the board resolution in February 2012. That was the date of the only “operative decision” that had been made.
In addition, there was no suggestion the board of directors who authorised the payment were influenced by a desire to give a preference.
While the ruling provides invaluable clarity for distressed companies and directors, it is important to note that each case will be decided on the facts and the surrounding circumstances that led to the transaction/s in issue. Always take expert legal advice where there is concern about a proposed payment to a creditor or if a dispute has already arisen.
1Darty Holdings SAS v Geoffrey Carton-Kelly (As Additional Liquidator of CGL Realisations Limited) [2023] EWCA Civ 1135
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