Unfair Preferences Flashcards
What governs unfair preferences?
(governed by s36 of BAD 1985 Act and s243 Insolvency Act 1986)
Must read s36 — this provides that 6 months before the date of sequestration a transaction entered into can be struck down, but it has to be a transaction which is to the prejudice of the general body of creditors. The classic examples of this are paying off one rather than the other creditors or giving a security to one existing creditor which will protect their position and ignoring other creditors.
When do unfair preferences occur?
Unfair preferences occur when an absolutely insolvent debtor pays a creditor in certain circumstances which give the creditor an unfair preference or advantage over other creditors. It also covers situations where an unfair security is granted to a creditor. NB this applies only when you are advantaging an existing creditor.
⁃ e.g. A owes £100k to each of B, C, D, E, F. A has £200k worth of assets. Of this £200k worth of assets A has one house worth £100k. Initially if A goes bust each of the creditors will be entitled to share pro rate in the £200k (each getting £40k each). But if A grants a standard security over his house for £100k to B then the total amount available to other creditors is now £100k meaning that the other creditors will only receive £25k each.
As with gratuitous alienations, there exist both common law and statutory provisions governing this area. Furthermore, the procedure is the same: a creditor or trustee seeking to challenge an alleged preference must do so officially and have the transfer reduced.
What is the general rule under the common law?
The general rule is that a debtor must - at the time of insolvency - treat all creditors equally and according to their rights as then established. No preference can be given to a creditor after insolvency if such did not exist prior to insolvency.
The grounds that the challenger must prove at common law are given above in the general material on fraudulent transactions
See, Wylie, Stewart & Marshall v Jervis 1913 1 SLT 465 [son in debt to father transfers house to latter].
What are non-challengeable payments?
Some transactions cannot be challenged in the 6 month period.
(1) Payments in cash for debts that are actually due
- If cash payment then you are fine, if it a debt that’s due.
An insolvent who has in his hands funds sufficient to meet a debt which is immediately due is, if he pays the debt in cash, doing no more than he is bound to do. This is not considered to be a voluntary act, and it is therefore necessarily exempt from challenge. A cheque is regarded as payment in cash in this regard.
See, Whatmough’s Trustee v British Linen Bank 1934 SC (HL) 51 [sale of bus business/overdraft].
(2) Transactions in the ordinary course of business (subsection 2)
- So paying ordinary bills as they fall due is fine (e.g. Electricity and gas)
Even if an insolvent is conscious of his insolvency, he remains free at common law to continue in business and so transactions which are in the ordinary course of that business are protected from challenge. If, however, financial difficulties cause him to depart from the ordinary course of business, the transactions are reducible.
**(3) Reciprocal Obligations (nova debita) — “it is a defence if parties undertake…unless it is a reciprocal obligation.
e.g if A owes £100k to B, 100K to C, 100k to D, and 100k to E.
A has £200k worth of assets which includes a house worth £100k.
F comes along and says to A I will lend you £100k but I want a security first over the house (£100k). The net effect is that A’s assets have increased by 100k (loan by F) but they have decreased by 100k in that there is now a security over the house.
The net impact on the assets is neutral, it has no been to the prejudice of all the other creditors.
The creditors still have the entitlement to the amount as before.
This is an example of a reciprocal obligation (grant of security is in return for something).
NB now look at Clayton’s Case (idea that where you have an overdrawn account, the earliest credit meets the earliest debit). If it is ’New debts' (nova debita), it is fine to have a security affecting it. So a security is perfectly valid to the new debt, the security is only challengeable to the debt which existed at the time that the security was entered into. Example 2: if you have money paid in and money paid out: draw a timeline. £100k, then security is granted. Then this security is challengeable if the debtor becomes sequestrated or liquidated within 6 months of that security. If the day after the security 10k is put into the account, then 30k is withdrawn the day after, then 20k is put in. The rule in Clayton’s case says earliest debt pays the earliest debt. So the 10k pays off 10k of the 100,000 which goes to 90k. Then 30k withdrawn = 120k, then 20k is used to pay off the next debt = 100k still due. But any debts incurred after the security is granted, the security is perfectly good in relation to (novus debitum). But the security is voidable to the value of the new debt.
There is no prohibition to an insolvent contracting new debts even once insolvent. Furthermore, there is no prohibition on him giving such a new creditor a preference compared to old creditors. The law on unfair preferences concerns the unfair treatment of existing creditors not new creditors.
The rule comes from Glove Company (case). Which confirms that the Clayton case replies to unfair preferences.
[THIS IS AN EXAM FAVOURITE****]
s 36 1985 Act, s 243 1986 Act
Says A preference created in favour of a creditor made within 6 months of sequestration or the grant of a trust deed or the commencement of winding up can be struck down.
NB See new BAD provisions*** 120 days!
What is a preference?
Security for a debt.
Assisting creditor to execute diligence.
Arranging for another debtor to pay the creditor
Sham sales for existing debts (possession retained).
Who is an unfair preference voidable at the instance of?
An unfair preference is voidable at the instance of creditors, the trustee, or the liquidator or administrator
Which transactions can be challenged?
Some transactions cannot be challenged:
⁃ 1) Transactions in the ordinary course of trade or business
⁃ e.g. Trade debts as they fall due.
⁃ 2) Payments in cash (includes payment by coins and banknotes, banker’s draft, cheques, and bills) unless collusive
⁃ 3) Nova debita – where debtor and another party have reciprocal obligations – there is therefore no diminution in value of the debtor’s estate. A security for a new debt is fine, not a security for an old debt. However, not if collusive.
⁃ But this causes a problem in relation to Clayton’s Case.[ 47 mins of second last lecture.]
⁃ 4) Mandate to release arrested funds.[ Don’t worry about this.]
On collusion see Nordic Travel Ltd v Scotprint Ltd 1980 SC 1
What is the remedy for unfair preferences?
Reduction or such other redress is appropriate.
INSOLVENCY ACT 1986 s 245
(must read)**
⁃ If a floating charge is granted in the 1 year period before liquidation (or 2 years if “connected with” you in the 2 years before liquidation), the floating charge can be struck down (challenged)
⁃ There is a defence based on the nova debita exception.
- If a floating charge is granted in exchange for a new loan it is going to be fine, but if it is granted to secure an existing debt there is a problem.
If the charge is created in favour of a person connected with the company the time period is within 2 years of the commencement of winding up or administration (“connected with” means directors and others (associates) : see s 249 and 435 of the 1986 Act).
Otherwise the time period is 12 months provided that the company was unable to pay its debts at the time the charge was created: see s 123, 1986 Act.
However, not if the floating charge is for nova debita.
Re Yeovil Glove Co – Clayton’s case,
current accounts and unfair preferences
What happens to the creditor’s debt if the charge is reduced?
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