Unfair Preferences – A Basic Framework
When a company goes insolvent there is usually a queue of creditors seeking to be repaid for goods or services they have supplied the company. Unfortunately, it is often the case that when a company winds up there is not enough money to pay all the creditors.
When there is not enough money to pay the creditors, the creditors each receive only a percentage of the total debt they are due.
To maximise the amount of money each creditor may receive, a liquidator may reclaim money the company has paid to its creditors during the last six months as ‘unfair preferences’.
Preferential Payments at Work
Imagine the company “Bob’s Apples”. Bob’s Apples isn’t doing very well financially and only has $1,000 left. Further, Bob’s Apples owes five creditors $500 each. Several months before Bob’s Apples winds up, Bob pays two of the creditors back in full and ignores the remaining three.
Under the unfair preference regime, a liquidator can demand the money back from the two paid creditors, and then can give each creditor a share of the total money owing to them. In the above situation, unfair preferences will see that each of the creditors receives $200 (being an equal share of the $1,000 left).
The Take Home Message
You should take care when dealing with companies that aren’t doing well financially, because if they wind up, you might have to repay any money the company has paid to you in the last six months.
This article was written by Daniel Sparrow