How to Challenge a Preferential Payment to a Creditor

In England and Wales, company insolvency law is designed to ensure that all unsecured creditors are treated fairly and equitably. A preferential payment occurs where an insolvent company makes a payment to one creditor that puts them in a better position in the event of insolvency than other creditors would otherwise be. Insolvency practitioners such as liquidators and administrators can challenge these payments under Section 239 of the Insolvency Act 1986 and seek orders from the court setting aside the transaction so that the value is restored to the company's estate. This article explains the legal framework, how preferential payments are identified, the process for challenging them, relevant time limits and practical steps involved. It is written to be accessible to solicitors, students and members of the public alike.

What Is a Preferential Payment?

A preferential payment is a transaction entered into by a company before insolvency that improves the position of a creditor, a guarantor or a surety compared with the position they would have had if the company had gone straight into insolvency without the payment. The effect of the transaction, not just the form, determines whether it is preferential.

To successfully challenge such a payment, the insolvency office‑holder must prove that:

• The payment had the effect of improving the creditor's position if the company became insolvent;
• The payment was made within the statutory “look‑back” period before insolvency; and
• The company was influenced by a desire to prefer that creditor.

Who Can Challenge a Preferential Payment?

Only an insolvency office‑holder - that is, the appointed liquidator or administrator - has statutory authority to bring a claim under Section 239 IA 1986 to set aside a preferential payment. This is part of their duty to maximise recoveries for the benefit of all creditors. Ordinary creditors cannot directly bring a preference claim, although in limited circumstances an office‑holder may assign the right to pursue the claim to a creditor.

Relevant Time Periods for Challenging Preference Payments

The law sets specific “relevant time” periods during which a payment may be challenged as a preference:

• Payments made within six months of the onset of insolvency are within the relevant period for ordinary creditors.
• Payments to connected persons - such as directors, family members, associated companies or close associates - may be challenged if made within two years before insolvency.

Whether a person is “connected” is defined in statute and includes relationships that are more than casual or purely commercial. Connected status affects not just time limits but also legal presumptions discussed below.

Key Legal Test: Desire to Prefer

The central element in a preference challenge is whether the company was influenced by a desire to put the creditor in a better position than they would otherwise have been in insolvency. This is a subjective test focusing on the mindset of those making the decision at the relevant time, not merely whether the creditor benefited.

Crucially:

• The company's actual desire to prefer must be shown. Simply benefiting a creditor is not enough if the decision was motivated by genuine commercial reasons.
• However, where the recipient is a connected person, the law presumes that the company was influenced by a desire to prefer, and it is for the recipient to rebut that presumption.

These legal tests encourage equitable treatment, recognising that directors sometimes make distress‑motivated decisions that may inadvertently disadvantage other creditors.

When the Company Must Have Been Insolvent

For a preference application to succeed, the company must have been unable to pay its debts either at the time of the transaction or as a consequence of it, measured under the statutory tests for insolvency (cashflow or balance sheet). If this element cannot be established, a preference claim is unlikely to succeed.

The Claims Process

Investigation and Identification

Once a company enters insolvency proceedings, the office‑holder conducts a detailed review of the company's financial affairs, including all payments made in the statutory look‑back period. This often involves forensic examination of bank records, ledger entries, creditor statements and board minutes.

Preparing the Court Application

If a transaction is identified as potentially preferential, the office‑holder will prepare an application to the High Court (or appropriate insolvency court) for an order under Section 239 IA 1986. This must include:

• Evidence of the transaction and its timing;
• Evidence that the company was insolvent at the time or became so as a result;
• Evidence of a desire to prefer the creditor.

The claimant may also provide witness statements and expert evidence to support assertions about insolvency status and intent.

Service and Hearing

The application is served on the party who received the alleged preference. That party can then file a defence, including evidence that counters the office‑holder's assertions. Common issues raised in defence include lack of desire to prefer, absence of insolvency at the relevant time, or that the party was not a creditor in the relevant period.

The court will hear submissions, assess the evidence, and determine whether the transaction meets the statutory criteria.

Possible Court Orders and Outcomes

If the court finds that a preferential payment was made:

• It may set aside the transaction, treating it as if it had not taken place;
• It can order the recipient to repay the value of the payment into the company's insolvency estate for distribution among all creditors;
• It may adjust orders to reflect circumstances, particularly where the asset has been spent or realised.

Recovery of preferential payments restores value to the estate, helping to satisfy creditor claims on a pari passu basis.

Defences and Practical Considerations

No Desire to Prefer

A respondent may argue that the payment was made for legitimate commercial reasons, such as preserving supply relationships, and not with an intention to improve the creditor's position in insolvency. Proving this may require evidence of wider commercial context and board decision‑making.

Outside Relevant Time

If the payment was made outside the statutory period - more than six months before insolvency for ordinary creditors, or more than two years for connected persons - no preference claim normally lies unless other legal remedies apply.

Good Faith and Consideration

Payments made in good faith and in return for new value or services are not preferential if they do not improve a creditor's position relative to others. This is particularly relevant where payment reflects genuine performance under a commercial contract.

Risks and Consequences

Challenging preferential payments can involve legal costs and procedural complexity. Office‑holders must weigh the likely recovery against potential costs. For the recipient, successfully defended claims may avoid repayment orders, but unsuccessful defences can lead to forced repayment and possible scrutiny of conduct prior to insolvency.

Common Questions

Can a creditor avoid being challenged if they did not know about insolvency?
Knowledge of insolvency does not necessarily affect liability; what matters is whether the company was influenced by a desire to prefer that creditor at the relevant time. However, evidence that the recipient had no notice of insolvency may be relevant in defences.

Does a court need proof of dishonesty?
Preference claims do not require fraud or dishonesty. The statutory test focuses on whether there was a desire to put the creditor in a better position, which is separate from dishonesty.

Can the liquidator recover more than the amount of the preference payment?
Court orders are generally designed to restore what was otherwise lost to the estate, which may include interest or value adjustments, subject to judicial discretion.

Key Takeaways

Challenging preferential payments is a specific legal right available to insolvency office‑holders under Section 239 of the Insolvency Act 1986. A preferential payment arises when a company's pre‑insolvency transaction improves the position of a creditor compared with what would have occurred in formal insolvency. To succeed, an office‑holder must show that the payment occurred within the statutory period, the company was insolvent at the time or as a result, and that it was influenced by a desire to prefer the creditor. If these elements are met, the court can set aside the transaction and order repayment into the insolvency estate, promoting equitable treatment of creditors and protecting the collective creditor pool.