When a company becomes insolvent, as a director, one of your main responsibilities is to act in the best interest of your creditors.
Under the ‘pari passu’ principle, all creditors must be treated fairly and equally in terms of repayments, and to do otherwise is considered unlawful.
As such, making preferential payments is a big no-no and can result in severe consequences, so it’s really important that company directors understand the Insolvency Act 1986 to ensure they don’t act unlawfully.
For many, it can be tempting to pay employees before entering insolvency or liquidation – but this is actually a form of preferential payment too, so it’s important to play by the rules. Read on to find out more about preference payments in liquidation…
Your questions about preference payments answered:
What is a preference payment?
A preference payment occurs when a company pays a specific creditor or group of creditors ahead of others, making them better off than the other creditors before going into a form of insolvency such as administration or liquidation.
However, in order for the payment to be a preference, there must be a proven desire to make that particular creditor better off.
According to section 239 of the Insolvency Act 1986, if a company enters insolvency, the insolvency practitioner will scrutinise all transactions up to two years prior to the insolvency to check for preferential payments.
If the directors are found to have created a preference, for example, by paying their employees before entering into insolvency, then they could end up becoming personally liable for the company debts.
What is the correct order of payment?
When a company is wound up, all the funds, assets, and income is collected, and the creditors are paid in order of priority.
Secured creditors such as banks and major financial institutions are paid first, followed by preferential creditors – which is where employees fall in the hierarchy of payments.
Next up are secured creditors with a floating charge, unsecured creditors, and finally shareholders. Find out more about the order of priority payments here.
Preference payments and employees
Although paying your employees before the company is liquidated can seem like a noble gesture, under section 239 of the Insolvency Act, it would put the employees in a better position than the other creditors.
If it can then be proven that there was intent to make your employees better off ahead of others, this could be seen as a preference payment.
In this situation, it may well be the employees who end up paying the money back to the liquidator, and if wrongful trading is proven, as the director you could end up being disqualified.
So, it’s definitely not the best route to go down!
So how can I look out for my employees?
Rest assured though that there is a safety net of measures in place to reduce the financial hardship of your employees should your business become insolvent and enter liquidation.
When a company enters liquidation, all contracts are terminated upon the publication of a winding up order or when the passing of a resolution to wind up the company is passed.
If there is no money left to pay them after secured creditors have been paid, they will be entitled to claim redundancy from the Redundancy Fund. They will also receive additional payments in lieu of notice, holiday pay and any payment arrears (capped to £544 per week).
All payments are processed by the Redundancy Payments Service (RPS) and are paid out of the National Insurance Fund (NIF). However, it’s important to note that the RPS cannot process any claims until an insolvency practitioner has been appointed.
So, the sooner you act, the better the outcome will be for your employees.
What can employees claim for?
Claims can be made for the following:
- Statutory Redundancy Payment
- Holiday pay (up to a maximum of six weeks)
- Notice pay for the statutory minimum notice period
- Arrears of wages (up to a maximum of eight weeks)
- A basic award ordered by an Employment Tribunal as a result of any unfair dismissal claim.
Because the amount that can be claimed is capped, employees can choose to claim the remainder of what they are owed from their employer.
However, given the financial state of the business and the order of priority of payments, they are unlikely to receive their payments in full.
Need more advice?
If your business is facing financial difficulty and you are unsure what to do next, or if you need further advice about preference payments in liquidation, McAlister & Co is here to help.
Our team has over 20 years of experience in business insolvency and company rescue, so will be more than happy to help you navigate through your financial difficulties.
Contact us today for a free, confidential chat to find out more about preference payments in liquidation, or alternatively, download our guide on how to take care of your employees during insolvency.