Who gets what when companies go bump?

Patrick Tedstone of ORJ Law asks who gets paid when insolvency looms

Global events since January 2020 have brought insolvency – or the threat of it – to thousands of companies and organisations throughout the UK. Many will have begun the year with significant cash on their balance sheets and may have been in the process of distributing, or planning to distribute, dividends and other funds to creditors.

So what happens now? When a business goes into insolvency, or if it is a foreseeable future occurrence, the question arises: how should it distribute funds to those it owes money?

Insolvency law is designed to make sure that a company’s suppliers, employees and all other stakeholders are treated fairly and that their losses are kept to a minimum.  In other words, an ailing company cannot show undue preference to certain creditors at the expense of everyone else.

The two-year rule

In most cases, payments to creditors made more than two years before insolvency is declared will not be challenged, unless this was deliberately intended to put assets beyond other creditors. But as recent events have proved, two years is a long time in business.

There may be many transactions within that timeframe that could be reviewed by insolvency practitioners and even legally challenged. They will be looking to establish whether owner-managers have given preference to favoured suppliers over the ‘general body’ of creditors.

A distribution payment may also be challenged if the business is unable to pay its debts at the time of payment. This will be determined by assessing the company’s assets and liabilities at that moment. To avoid falling foul of this test, it may be necessary to produce evidence of your trading status at that time.

A further complication arises if the distribution payment itself causes the company to become insolvent, even if it was not beforehand.

Preferential treatment

Where a payment is made by a company unable to meet its debts, this does not automatically mean a challenge will succeed. The insolvency practitioner still has to prove ‘a desire to prefer’. In other words, the company must be intentionally favouring one creditor over others. But how can that intention be proved? And how can such a ‘desire’ be shown to have influenced the distribution decision?

If the distribution payment was planned long ago, then this would mitigate against the idea that it was unfair or showed undue favour to that creditor. So in that particular example, it would be prudent to record the decision-making process for future reference. But this factor, along with a raft of other considerations, will be taken into account before any judgement is reached.

Each insolvency is unique: There are differing timescales, differing circumstances and differing amounts at stake in every case. That is partly why it is such a complex area of the law – and why it pays to have a specialist on your side to help steer you through.

If you are facing insolvency now, or consider it a likely prospect in the foreseeable future, you can speak to ORJ Solicitors. We have several skilled and experienced lawyers who understand the ever-changing landscape of insolvency law and who help our clients navigate these rocky waters every day.

For an exploratory discussion, call Patrick, Lorraine or Mike at ORJ Law: 01785 223440