Unfair preference
Encyclopedia
An unfair preference is a legal term arising in bankruptcy law where a person or company transfers assets or pays a debt to a creditor
shortly before going into bankruptcy
, that payment or transfer can be set aside on the application of the liquidator
or trustee in bankruptcy
as an unfair preference or simply a preference.
The law on unfair preferences varies from country to country, but characteristically, to set a transaction or payment aside as an unfair preference, the liquidator will need to show that:
In most countries an application to have a transaction set aside as a preference can only be made by the liquidator or trustee in bankruptcy (as the person making the payment must be in bankruptcy, and thus they are not normally liable to suits from other creditors).
The effect of a successful application to have a transaction declared as an unfair preference varies. Inevitably the creditor which received the payment or assets has to return it to the liquidator. In some countries the assets are treated in the normal way, and may be taken by any secured creditor
s who have a security interest
which catches the assets (characteristically, a floating charge
). However, some countries have "ring-fenced" recoveries of unfair preferences so that they are made available to the pool of assets for unsecured creditor
s.
An unfair preference has some of the same characteristics as a fraudulent conveyance
, but legally they are separate concepts. There is not normally any requirement to prove an intention to defraud to recover assets under an unfair preference application. However, similar to fraudulent conveyance applications, unfair preferences are often seen in connection with asset protection
schemes that are entered into too late by the putative bankrupt.
Many jurisdictions provide for an exception in the case of transactions entered into in the ordinary course of business
with a view to keeping the company trading, and such transactions are usually either validated or presumed to be validated.
is a transfer of property by a debtor to its creditor, on account of a pre-existing debt, that is made while the debtor is insolvent and gives the creditor more than it would obtain in a liquidation of the debtor's assets in a bankruptcy
proceeding. It is primarily a creature of the U.S. Bankruptcy Code, although some states have similar state laws. If the preferential transaction takes place within a specified period of time before the filing of bankruptcy by or on behalf of the debtor, then the debtor's trustee in bankruptcy is authorized to recover the property preferentially transferred. The mechanism of recovery is the avoidance of the transfer. After such avoidance, the recovered property becomes property of the bankruptcy estate. The period is usually 90 days. However, if the preferential transfer is made to an "insider," then the period is one year. An "insider" is generally a relative or one who has the ability to control the activities of the debtor. The Bankruptcy Code provides some exemptions from these rules to accommodate transfers intended to be contemporaneous, made in the ordinary course of business or to the extent they are made for new value, and others.
All of the following examples assume that the requirements for a preference that are set out above exist at the time the transfer is made.
.
Creditor
A creditor is a party that has a claim to the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption that the second party will return an equivalent property or...
shortly before going into bankruptcy
Bankruptcy
Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
, that payment or transfer can be set aside on the application of the liquidator
Liquidator (law)
In law, a liquidator is the officer appointed when a company goes into winding-up or liquidation who has responsibility for collecting in all of the assets of the company and settling all claims against the company before putting the company into dissolution....
or trustee in bankruptcy
Trustee in bankruptcy
A trustee in bankruptcy is an entity, often an individual, in charge of administering a bankruptcy estate.- United States :In the United States, a Trustee in Bankruptcy is a person who is appointed by the United States Department of Justice or by the creditors involved in a bankruptcy case.In a...
as an unfair preference or simply a preference.
The law on unfair preferences varies from country to country, but characteristically, to set a transaction or payment aside as an unfair preference, the liquidator will need to show that:
- the person or company was insolvent at the time the payment was made (either on the cash-flow test, or on the balance sheet test - it varies from country to country)
- the person or company then went into bankruptcy within a specified time thereafter, usually referred to as the vulnerability period
- the payment had the effect of putting the creditor in a better position than other unsecured creditorUnsecured creditorAn unsecured creditor is a creditor other than a preferential creditor that does not have the benefit of any security interests in the assets of the debtor....
s - in some jurisdictions, it is also necessary to show that the bankrupt intended to grant a preference.
In most countries an application to have a transaction set aside as a preference can only be made by the liquidator or trustee in bankruptcy (as the person making the payment must be in bankruptcy, and thus they are not normally liable to suits from other creditors).
The effect of a successful application to have a transaction declared as an unfair preference varies. Inevitably the creditor which received the payment or assets has to return it to the liquidator. In some countries the assets are treated in the normal way, and may be taken by any secured creditor
Secured creditor
A secured creditor is a creditor with the benefit of a security interest over some or all of the assets of the debtor.In the event of the bankruptcy of the debtor, the secured creditor can enforce security against the assets of the debtor and avoid competing for a distribution on liquidation with...
s who have a security interest
Security interest
A security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation, usually the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
which catches the assets (characteristically, a floating charge
Floating charge
A floating charge is a security interest over a fund of changing assets of a company or a limited liability partnership , which 'floats' or 'hovers' until conversion into a fixed charge, at which point the charge attaches to specific assets...
). However, some countries have "ring-fenced" recoveries of unfair preferences so that they are made available to the pool of assets for unsecured creditor
Unsecured creditor
An unsecured creditor is a creditor other than a preferential creditor that does not have the benefit of any security interests in the assets of the debtor....
s.
An unfair preference has some of the same characteristics as a fraudulent conveyance
Fraudulent conveyance
A fraudulent conveyance, or fraudulent transfer, is a civil cause of action. It arises in debtor/creditor relations, particularly with reference to insolvent debtors. The cause of action is typically brought by creditors or by bankruptcy trustees...
, but legally they are separate concepts. There is not normally any requirement to prove an intention to defraud to recover assets under an unfair preference application. However, similar to fraudulent conveyance applications, unfair preferences are often seen in connection with asset protection
Asset protection
Asset protection is a set of legal techniques and a body of statutory and common law dealing with protecting assets of individuals and business entities from civil money judgments...
schemes that are entered into too late by the putative bankrupt.
Many jurisdictions provide for an exception in the case of transactions entered into in the ordinary course of business
Ordinary course of business
In law, the ordinary course of business covers the usual transactions, customs and practices of a certain business and of a certain firm. This term is used particularly to judge the validity of certain transactions...
with a view to keeping the company trading, and such transactions are usually either validated or presumed to be validated.
United Kingdom
- Insolvency Act 1986Insolvency Act 1986The Insolvency Act 1986 is an Act of the Parliament of the United Kingdom that provides the legal platform for all matters relating to personal and corporate insolvency in the UK.-History:...
section 239 - Re MC Bacon Ltd (No 1)Re MC Bacon Ltd (No 1)Re MC Bacon Ltd [1990] BCLC 324 is a leading UK insolvency law case, concerning transactions at an undervalue and voidable preferences .-Facts:...
United States
A preference in U.S. federal bankruptcy lawBankruptcy in the United States
Bankruptcy in the United States is governed under the United States Constitution which authorizes Congress to enact "uniform Laws on the subject of Bankruptcies throughout the United States." Congress has exercised this authority several times since 1801, most recently by adopting the Bankruptcy...
is a transfer of property by a debtor to its creditor, on account of a pre-existing debt, that is made while the debtor is insolvent and gives the creditor more than it would obtain in a liquidation of the debtor's assets in a bankruptcy
Bankruptcy in the United States
Bankruptcy in the United States is governed under the United States Constitution which authorizes Congress to enact "uniform Laws on the subject of Bankruptcies throughout the United States." Congress has exercised this authority several times since 1801, most recently by adopting the Bankruptcy...
proceeding. It is primarily a creature of the U.S. Bankruptcy Code, although some states have similar state laws. If the preferential transaction takes place within a specified period of time before the filing of bankruptcy by or on behalf of the debtor, then the debtor's trustee in bankruptcy is authorized to recover the property preferentially transferred. The mechanism of recovery is the avoidance of the transfer. After such avoidance, the recovered property becomes property of the bankruptcy estate. The period is usually 90 days. However, if the preferential transfer is made to an "insider," then the period is one year. An "insider" is generally a relative or one who has the ability to control the activities of the debtor. The Bankruptcy Code provides some exemptions from these rules to accommodate transfers intended to be contemporaneous, made in the ordinary course of business or to the extent they are made for new value, and others.
All of the following examples assume that the requirements for a preference that are set out above exist at the time the transfer is made.
- Securing a previously unsecured debt.
- Substituting property of greater value as security for existing security property whose value is insufficient to completely secure repayment of the debt.
- Paying some but not all unsecured creditors.
- In a real estate transaction, delaying the recording of a mortgage for more than 30 days after the debt it secures is created.
Switzerland
Under Swiss law, creditors who hold a certificate of unpaid debts against the debtor, or creditors in a bankruptcy, may file suit against third parties who have benefited from unfair preferences or fraudulent transfers by the debtor prior to a seizure of assets or a bankruptcyBankruptcy
Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
.