Preferential transactions (section 239 Insolvency Act 1986)
Section 239(4) of the Insolvency Act 1986 provides that a company gives a preference to a person if:
(a) that person is one of the company's creditors or a surety or guarantor for any of the company's debts or other liabilities; and
(b) the company does anything or suffers anything to be done which (in either case) has the effect of putting that person into a position which, in the event of the company going into insolvent liquidation, will be better than the position he would have been in if that thing had not been done.
In order for a transaction to be successfully attacked as a preferential transaction, the company must have given the preference within a 'relevant time' which is six months ending on the onset of insolvency for an unconnected person and two years for a connected person. However, for the time to be 'relevant', the company must have been insolvent at the time of entering into the transaction or to have become so, as a result of the transaction, but this will be presumed, unless the contrary is shown, if the beneficiary is connected.
Therefore, it is critical to determine whether a particular transaction involves a person which is considered a “connected person” for the purposes of section 239. Establishing whether a person is 'connected' or not can be complicated. To decide one should look first at section 249 which lists directors and shadow directors as well as associates of such persons and associates of the relevant company. Associate is defined in section 435 and, in addition to family members, includes sister subsidiaries and persons with control. A person has 'control' of a company if either the directors are accustomed to act in accordance with that person's instructions or the relevant person is entitled to exercise, or control the exercise of, a third or more of the voting rights of the relevant company. The close ties of a connected person with either the company itself or its management justify the stricter approach adopted by section 239 as regards transactions with such persons.
It should be noted, though, that no order can be made under section 239, unless the company which gave the preference was influenced in deciding to give it by a desire to put the person into a position which, in the event of the company going into insolvent liquidation, will be better than had nothing been done. Such a desire is presumed where the beneficiary of the preference is a connected person.
Now, if a transaction meets all the above requirements and the company is shown to have given a preference, a liquidator or administrator may apply to the court for an order to unwind such transaction. As with a transaction at an undervalue, any successful recovery by a liquidator or an administrator is for the benefit of the creditors generally and will not be caught by any pre-existing floating charge created by the company.
A typical example of a potentially preferential transaction is security being given at a later date to secure existing indebtedness. However, even on this instance, whether or not the transaction will ultimately be set aside by the court, does largely depend on the circumstances. If, for example, security is given to secure the continued availability of the funds, then the lender should be able to claim that the company had no desire to prefer it as such, it simply wished to ensure the continued availability of the facilities. Security given for new monies also can never be a preference. Where a lender appears to be more vulnerable is where a director has, for example, given a guarantee and procures that the company shall provide the bank with security in exchange of the bank releasing the director’s guarantee. However, in a case where a director who had given a guarantee procured that the company repaid its bank facility, so that his guarantee could not be called, it was held that such repayment was not a preference as the bank was fully secured in any event.
