A preference payment liquidation claim happens when a liquidator finds that money or an asset was given to one creditor, shortly before insolvency, putting them in a better position than other creditors would have expected. If a liquidator decides a payment was an unlawful preference, they can apply to court to have it reversed and the money paid back into the company for everyone's benefit.
This matters to any director who has been tempted to pay a favoured supplier, settle a personal guarantee, or repay a director's loan while the company was struggling. The rules exist under the Insolvency Act 1986 to stop one creditor jumping the queue at the expense of everyone else.
This article explains what counts as a preference, how the "desire to prefer" test works, why connected-party payments carry extra risk, and how directors can keep paying legitimate bills without falling foul of the rules.
What counts as a preference payment in liquidation
A payment or transaction is a preference under section 239 of the Insolvency Act 1986 when it puts a creditor, guarantor or surety in a better position on insolvency than they would otherwise have been in, and the company was influenced by a desire to achieve that result.
Common examples include:
- Paying off a supplier who is also a friend, family member or connected business
- Repaying a director's loan ahead of trade creditors
- Releasing a personal guarantee by paying the guaranteed debt in full
- Giving one creditor security (such as a charge over an asset) that others do not have
Ordinary trading payments made in the normal course of business, at arm's length and for genuine commercial reasons, are usually not a preference. The risk arises when a payment looks like it was chosen to benefit one creditor specifically, rather than to keep the business running.
The "desire to prefer" test
Not every payment that happens to help one creditor is unlawful. The court must be satisfied that the company was influenced by a genuine desire to put that creditor in a better position, not simply that the payment had that effect.
In practice, a liquidator or the court will look at evidence such as:
- Why that particular creditor was paid, and why then
- Whether the relationship between the director and creditor was close or connected
- The company's financial position at the time — was it already insolvent or heading that way?
- Any pressure that genuinely forced the payment, such as a supplier threatening to stop deliveries the company needed to keep trading
A payment made under real commercial pressure, to keep an essential supplier on side, is treated very differently from one made simply because the director wanted to look after someone.
Connected parties and the longer look-back period
Timing matters. A liquidator can generally challenge a preference made in the two years before the company entered insolvency if the creditor was a connected person — a director, shadow director, or a person or business connected to them.
For payments to creditors who are not connected, the look-back period is shorter, at six months before insolvency. These "relevant time" rules are set out in section 240 of the Insolvency Act 1986 and reflect the higher risk that directors will look after people close to them first. If you are unsure whether a creditor counts as connected, our article on Am I Personally Liable for Company Debts? covers how personal and connected-party exposure is assessed more broadly.
Preferences are also closely linked to transactions at undervalue, another type of pre-insolvency transaction a liquidator can unwind, so the two are often reviewed together.
Why repaying yourself or family is high-risk
Repaying a director's loan account, or paying a family member's invoice, is one of the most common preference risks a liquidator investigates. Because directors are automatically connected persons, there is a presumption that any such payment was influenced by a desire to prefer, unless the director can show otherwise.
This does not mean directors can never be repaid what the company genuinely owes them. It means the timing, amount and circumstances of any repayment made close to insolvency will be scrutinised carefully, and the burden is on the director to explain it.
What a liquidator can claw back
If a court agrees a payment was an unlawful preference, it can make an order to restore the position as if the preference had never happened. Depending on the case, this can include:
- Ordering the money or asset to be repaid to the company
- Releasing any security given to the preferred creditor
- Requiring the creditor to account for any benefit they received
This is often referred to as a preference clawback. The liquidator's job is to recover value for the whole body of creditors, not to punish the individual creditor who received the payment — although the director's own conduct can still lead to separate consequences.
The personal consequences for directors
A finding of unlawful preference is about the company's transactions, but it can have direct personal consequences for the director who authorised it. A court can order a director to personally contribute to the company's assets to make good the preference.
Preference payments are also something the Insolvency Service considers when assessing director conduct, alongside other issues such as wrongful trading or misfeasance claims against directors. In serious cases this can factor into disqualification proceedings, in addition to any repayment ordered by the court.
How to pay creditors safely near insolvency
Directors do not have to stop paying bills the moment cash flow tightens. The key is to keep decisions commercial, evidenced and even-handed. Steps that reduce preference risk include:
- Paying suppliers who are essential to keep trading, and recording why
- Avoiding payments to connected parties while other creditors go unpaid
- Getting independent advice before repaying director loans or settling personal guarantees
- Keeping clear records of the company's financial position when each decision was made
- Speaking to a regulated insolvency practitioner early if the company may already be insolvent
Gov.uk sets out a director's wider duties if a company is in financial difficulty, including the shift towards protecting creditors' interests as insolvency approaches — see the official guidance on running a company in financial difficulty.
Acting early, with proper advice, is the clearest way to show any later liquidator that decisions were made for the company's benefit, not to favour one creditor over another.
Frequently asked questions
How far back can a liquidator look for preference payments?
Generally six months before insolvency for unconnected creditors, and two years for connected persons such as directors, family members or connected businesses.
Is paying a supplier before liquidation always a preference?
No. Genuine, arm's-length payments made to keep essential supplies coming in are usually treated as ordinary trading, not a preference. Risk increases where the creditor is connected or the payment looks selective.
Can I repay my own director's loan before the company closes?
You can, but because directors are connected persons, the payment is likely to be scrutinised. A liquidator may treat it as a preference unless there is a clear, evidenced commercial reason for the timing.
What is a preference clawback?
It is the process by which a liquidator applies to court to reverse an unlawful preference, so the money or asset is returned to the company for the benefit of all creditors.
Does a preference finding always mean the director acted dishonestly?
No. The test looks at whether the company was influenced by a desire to prefer, not dishonesty. Even a well-intentioned payment can be unwound if it meets the legal test.
This article is general information, not legal, financial or insolvency advice, and does not cover every circumstance. Directors should speak to a regulated specialist about their own situation.
If you're concerned about payments made before a possible liquidation, Harbourfirst can introduce you to a regulated insolvency practitioner or solicitor to talk it through — start an enquiry.