How to Challenge a Preferential Transaction in Court

What Preferential Transactions Are in Insolvency

In insolvency law in England and Wales, a preferential transaction (also called a preference) occurs when a company on the brink of insolvency does something that puts one creditor in a better position than other creditors would have been if the company had entered insolvent liquidation without that transaction. This often involves paying or securing one creditor shortly before the start of formal insolvency proceedings. The law recognises that such payments or actions can unfairly prejudice the general body of creditors, and therefore gives insolvency practitioners powers to challenge and undo these transactions through the courts if certain statutory conditions are met.

Challenging a preferential transaction is a technical legal process grounded in the Insolvency Act 1986. This article explains how preferential transactions are challenged, the conditions that must be proved, the applicable time limits, practical steps to bring a court application, common defences, and what the courts may do if a challenge succeeds.

What a Preferential Transaction Is

A preferential transaction under section 239 of the Insolvency Act 1986 arises where a company does something that:

• Benefits a creditor, surety or guarantor of the company's debts;
• Puts that creditor in a better position than they would have been if the company had entered insolvent liquidation without the transaction;
• Occurs within a specified look‑back period before the onset of insolvency; and
• Is done when the company is insolvent or becomes insolvent as a result of it.

Examples include an unsecured creditor being paid in full shortly before liquidation, or security being granted to a creditor while other creditors remain unpaid.

The underlying policy is to uphold the principle of pari passu distribution, meaning creditors should be treated equally according to statutory ranking rather than having one favoured at the expense of others.

Who Can Challenge and When Challenges Can Be Made

Only certain parties can bring a challenge in court. In company insolvency, this is usually:

• The liquidator in a liquidation;
• The administrator in an administration.

These office‑holders have a statutory duty to investigate pre‑insolvency transactions and may apply to the High Court, or in some cases the Companies Court, for an order setting aside the preferential transaction.

A transaction can be challenged if it was made:

• Within six months before the start of the insolvency proceedings if the creditor was an unconnected person; or
• Within two years if the creditor is a connected person, such as a director, shadow director, associate or related party. There is a statutory presumption of a desire to prefer in connected cases unless the contrary is shown.

The company must have been unable to pay its debts at the time of the transaction or become so as a result. For connected parties, insolvency is presumed for the relevant period, but for unconnected parties it must typically be proved.

Elements the Court Will Consider

To succeed in a preference challenge, the applicant must satisfy the court that:

1. The Transaction Effected a Preference

The office‑holder must establish that the transaction improved the position of the recipient in potential insolvency compared to what that position would have been without the transaction. A simple advantage to a creditor does not automatically make it a preference; it must be shown that the purpose or effect was to favour the recipient over other creditors.

2. Timing Falls Within Relevant Period

The transaction must fall within the statutory look‑back period - typically six months for unconnected persons and two years for connected persons before the start of formal insolvency proceedings. These periods are designed to capture transactions that might otherwise defeat fair distribution.

3. Insolvency Requirement

The company must have been insolvent at the time of the transaction or have become so as a result of it. Proof of insolvency is sometimes required unless there is a statutory presumption because the recipient was connected.

4. Desire to Prefer

The office‑holder must show that the decision‑makers were influenced by a desire to put the recipient in a better position in the event of insolvency. This subjective element focuses on the mindset of those who authorised the transaction, often directors. A connected party benefit triggers a presumption of desire to prefer, reversing the usual burden.

A key judicial interpretation is that a mere advantage isn't enough; the preference must be driven by a purpose to prioritise that creditor's position in insolvency rather than being a commercial decision made for other reasons.

Steps to Challenge a Preferential Transaction

1. Investigation by the Insolvency Practitioner

Once insolvency proceedings start, the appointed liquidator or administrator will review the company's recent transactions. They typically scrutinise records from the statutory look‑back period to identify potential preferences. This investigation forms the basis for deciding whether a challenge should be pursued.

2. Preparation of Court Application

If a suspect transaction is found, the office‑holder prepares an application under section 239 IA 1986 to set aside the preference. The application must include evidence of:

• The nature of the transaction;
• The timing relative to insolvency;
• The insolvency status of the company at the time;
• Evidence suggesting a desire to prefer the recipient; and
• The identity of the recipient and their connection status.

Specialist legal advisers often assist in drafting and filing this application with the court.

3. Court Hearing and Evidence

The court will consider the evidence, including witness statements and financial records. Defendants may be called to explain or justify the transaction. Unlike some creditor‑creditor claims, challenging a preference is fact‑specific, and the court assesses whether the statutory criteria are met.

4. Orders the Court May Make

If the court is satisfied that a preference existed, it can make orders including:

• Setting aside the transaction so it is treated as if it never occurred;
• Ordering repayment of money or assets to the insolvency estate for distribution among creditors;
• Other relief as appropriate to restore the position of the insolvency estate.

Potential Defences to a Preference Claim

Respondents to a preference claim often raise points such as:

• The transaction did not constitute a preference because it was made in the ordinary course of business or in good faith;
• The company was not insolvent at the time of the transaction;
• There was no desire to preferentially favour the recipient;
• The transaction fell outside the relevant period; and
• The recipient was not a creditor, surety or guarantor at the relevant time.

In connected cases, where the presumption of desire to prefer applies, the defendant must produce evidence to rebut that presumption. Otherwise, the court may conclude that the statutory criteria were met.

Time Limits and Practical Timeframes

There is no general statute of limitations once insolvency proceedings are under way; the statutory “relevant time” periods determine when a transaction can be scrutinised. Six months applies to unconnected persons, and two years applies to connected persons for preferential claims, with insolvency or resulting insolvency needing proof or statutory presumption.

It is important to act promptly within insolvency proceedings to ensure all potential avoidable transactions are identified and, if appropriate, challenged before the estate is finalised.

Common Questions About Challenging Preferential Transactions

Can a creditor individually challenge a preference?
Generally, only the appointed liquidator or administrator can bring a preference challenge under the Insolvency Act 1986. A third party can apply with leave of the court if they can show they are prejudiced by the transaction.

Does paying a court judgment debt count as a preference?
Yes - paying a judgment debt shortly before liquidation can still be a preference if it satisfies the statutory criteria, including desire to prefer and timing.

Does security given for pre‑existing debt always constitute a preference?
Not necessarily. Whether security given shortly before insolvency is a preference depends on whether it improved the creditor's position relative to other creditors and if the statutory criteria are met, including desire to prefer.

Key Takeaways

Challenging a preferential transaction in England and Wales involves applying to the court under section 239 of the Insolvency Act 1986 to set aside a transaction that unfairly favoured one creditor over others in the period leading up to a company's insolvency. The liquidator or administrator must demonstrate that the transaction improved the position of a specific creditor, took place within prescribed timeframes, and was influenced by a desire to prefer. The court will assess evidence of insolvency, timing and purpose and may order repayment or other relief to restore fairness among creditors. Defendants may challenge preference claims on grounds such as lack of insolvency, absence of a desire to prefer, or that the transaction was in the ordinary course of business. Successfully navigating a preference challenge requires careful factual analysis and engagement with the insolvency process early on.