When a company starts struggling financially, it’s natural to prioritise certain bills over others. You might pay off a family member who lent the company money, or make sure a key supplier gets paid so you can keep trading. While this might feel like common sense, in insolvency law it could be classed as a preferential transaction.
A preferential transaction happens when one creditor is treated more favourably than the rest, at a time when the company is already insolvent or nearing insolvency. In other words, if you pay one person in full while leaving others unpaid, you could be accused of putting them in a “preferred” position. This is something UK insolvency law is designed to stop.
What does the law say?
When a company enters liquidation, the assets are supposed to be shared fairly among creditors according to a set legal order. If directors could pick and choose who to pay just before insolvency, it would undermine this fairness.
The law aims to protect creditors as a group, making sure no one is unfairly advantaged. That’s why the Insolvency Act 1986 gives liquidators the power to challenge and even reverse preferential payments.
Examples of preferential transactions
Preferential transactions often come from good intentions. But they can create problems later. Common examples include:
Repaying family loans – If your spouse, parent or sibling lent the company money and you pay them back before liquidation, this could be seen as preferential.
Favouring directors or connected parties – Clearing a director’s loan account or repaying money owed to a fellow director could raise red flags.
Paying one supplier over others – Especially if you rely on that supplier to keep operating but other creditors remain unpaid.
Covering personal guarantees indirectly – If you pay a debt where you personally signed a guarantee, it could be classed as putting yourself in a better position than other creditors.
The “look-back” period
Liquidators have the power to examine payments made in the run-up to insolvency. The law sets out a look-back period:
Two years if the payment was to a “connected party” (such as a director, family member or associated company).
Six months for other creditors.
If a payment is judged to be preferential, the liquidator can demand the money back from the person or company who received it.
What are the consequences of a preferential transaction?
If preferential payments are identified, there are several possible consequences:
Reversal of the transaction – The liquidator can pursue the creditor who received the payment, demanding repayment into the liquidation pot.
Increased scrutiny of your conduct – Preferential transactions may trigger further investigation into how the company was managed in its final months.
Personal liability risks – If it’s shown that you acted deliberately to favour one creditor, you could face personal liability.
Director’s disqualification – In serious cases, the Insolvency Service may consider this misconduct and apply for director’s disqualification, which means you could be banned from acting as a director for a fixed period of time.
How to avoid preferential transactions
Preferential payments are often made without directors realising the consequences. The best way to protect yourself is to:
Stop making selective payments once insolvency is likely and treat all creditors fairly.
Document your decisions and, if you decide to make a payment, keep clear records of why.
Seek advice early from a licensed insolvency practitioner, who can guide you on what is and isn’t allowed.
Consider formal processes, for example entering a CVA, administration or Creditors’ Voluntary Liquidation (CVL) ensures payments are managed properly and fairly.
The difference between preferential and fraudulent trading
It’s important to note that preferential transactions are not the same as fraudulent trading. With preferential transactions, the director might have acted out of loyalty or pressure, without intending to defraud creditors.
Fraudulent trading involves knowingly running the company to defraud creditors or for a fraudulent purpose.
The law treats fraudulent trading far more severely. But both can put directors at risk if not handled correctly.
Why early advice makes all the difference
Many directors caught out by preference rules were simply trying to do the right thing: paying family back, keeping suppliers on side, or protecting personal guarantees.
The earlier you seek advice, the more options you’ll have to protect yourself and ensure you’re not left personally exposed. Acting quickly can help you:
- Avoid decisions that could be challenged later
- Understand your legal duties as a director
- Explore business rescue options before liquidation becomes inevitable
- Protect your personal position if insolvency can’t be avoided
Need help with questions about preferential transactions?
If your company is struggling with debt and you’re unsure about which payments you should (or shouldn’t) be making, the safest step is to get advice now.
Our licensed insolvency practitioners will explain your duties clearly, review your company’s financial position, and guide you on the right course of action. If preferential transactions have already been made, we’ll help you understand the consequences and work towards the best possible outcome.
Don’t risk making matters worse by acting without guidance. Contact us today for free, confidential advice and take control of what happens next.
