Voidable preference

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What happens if you create a security interest over existing indebtedness, and then go bust within a period specified by statute ( usually 6 months of thereabouts). The law will set aside such a security interest, supposing that in creating it a debtor was acting with base motives: preferring one of his buddies, to whom he owed money, over his legion other creditors, when the writing on the wall or his solvency made itself suddenly all too painfully clear.

Most jurisdictions have some kind of “anti-deprivation” principle in their insolvency regime which stops a struggling company preferring some of its creditors over other ones.

In the UK, it is section 239 of the Insolvency Act 1986, and it goes something like this:

For the purposes of this section and section 241, a company enters into a transaction with a person at an undervalue if—

(a) the company makes a gift to that person or otherwise enters into a transaction with that person on terms that provide for the company to receive no consideration, or

(b) the company enters into a transaction with that person for a consideration the value of which, in money or money’s worth, is significantly less than the value, in money or money’s worth, of the consideration provided by the company.

This is wide and loose, and gives an insolvency administrator power to stop companies preferring, you know, the director’s brother in law’s firm which supplies the copier paper. It gives those extending credit to struggling companies pause for thought, at any rate.

See also

• bankruptcy
• Carve-in
• Slavenburg