Preferential Treatment of a Creditor
Many companies have been hard hit by the global recession. In some cases, the company's ability to pay its debts has been severely and irreversibly impaired. When faced with such financial difficulties the company may be pressured or tempted to treat one creditor in a more favourable way than the treatment afforded to the general body of creditors. However, where this occurs the company may be found guilty of the offence of fraudulent preference under the Companies Act.
The law governing fraudulent preferences seeks to regulate how companies deal with their creditors in circumstances where the company is on the verge of insolvency. The aim is to ensure that all creditors are treated equally and share pari passu in the insolvent company's assets. As such, certain actions that are geared towards giving a creditor preference over other creditors will be deemed by law to be invalid.
The Companies Act provides that any conveyance, mortgage, delivery of goods, payment, execution, or other act relating to property, if made within six (6) months of the commencement of a company's winding up, is deemed to be a fraudulent preference of its creditors, or a fraudulent conveyance, assignment, transfer, sale or disposition, as the case may be.
To establish a case of fraudulent preference it must first be shown that the Company is facing insolvency. Insolvency generally refers to a situation where the company's liabilities exceed its assets. If this occurs, it may result in the company being wound up and its property administered for the benefit of creditors and shareholders.
Where fraudulent preference is alleged it must be proven that the substantial and dominant motive of the Company, in making the payment, was to favour a creditor or particular creditors. In practice, it is not easy to establish that a payment was a fraudulent preference, but there are cases that suggest that a payment to anyone otherwise than in the ordinary way of business within the six (6) month period could imply an intention to prefer.
Additionally, if it is proved that the debtor company, in imminent expectation of being wound up, voluntarily paid a particular creditor with the result of giving him a preference, and the reason for such payment is unexplained, a prima facie case of fraudulent preference is established.
The case of fraudulent preference would, however, be negated if it can be shown that the company, in the ordinary course of business, paid some of its creditors with such money as may have been available at the time provided there was reasonable ground for belief that it would be able to pay other creditors in the near future. Additionally, the case of fraudulent preference would also be negated in the following circumstances:
- if payment was made under pressure or fear of civil or criminal proceedings;
- if the payment was made in pursuance of a precedent contract or engagement;
- if the debtor believed it had a legal obligation to pay; or
- if the repayment of the money was advanced for a specific purpose.
It is important to note that, at common law, the innocence of the creditor in accepting the payment is totally immaterial to a finding of fraudulent preference.
If a case of fraudulent preference is established against the company, the liquidator is entitled to reclaim the money paid from the preferred person. The extent of the company's liability is the value of the property charged at the date when the transaction took place. Any subsequent appreciation or deprecation in the value of the property will not entitle the creditor to take advantage of the appreciation or disentitle him to recover the extent of the depreciation.
The current economic climate has exposed many companies to the harsh realities of insolvency. It is, therefore, imperative for companies to familiarise themselves with the legal provisions that are applicable in these circumstances. On November 30, 2011 Myers, Fletcher & Gordon will be hosting a seminar at the Knutsford Court Hotel which will be geared towards examining the laws that currently govern insolvency matters and the proposed reform of these laws. For information on the seminar please contact Ms. Moveta McNaught via firstname.lastname@example.org or 922-5860 ext 2547. We look forward to seeing you there!
"Kerry-Ann Heavens is an Associate at Myers, Fletcher & Gordon and is a member of the firm's Commercial and Intellectual Property Department. Kerry-Ann may be contacted via email@example.com or www.myersfletcher.com. This article is for general information purposes only and does not constitute legal advice."