Written by Jonathan Munnery, Insolvency & Restructuring Expert | Last updated: 7 May 2026 | Reading time: 4 mins
What is a preference payment?
If a company cannot pay its debts when they are due, or the total value of its liabilities exceeds its assets, it is technically insolvent. When a company is insolvent, the directors must protect the interests of their creditors as a whole. That means not favouring certain creditors ahead of others.
A preference payment occurs when you make a payment that puts one creditor, or a group of creditors, in a better position than the rest.
In practice, preference payments often involve:
- Payments to connected parties, such as friends, family members, business partners or other companies that are related to the directors or shareholders
- Payments to preferred suppliers or trade creditors
- Repaying debts secured by personal guarantees
- Repaying a director’s loan when other creditors remain unpaid
- Transferring company assets to a connected person
- Paying employee bonuses or commissions, particularly if they are friends or family members
How are creditor payments made during liquidation?
The aim of insolvent liquidation is to close the company in a fair, efficient and legally appropriate way under the supervision of a licensed Insolvency Practitioner. They will sell the company’s assets and use the available funds to repay the creditors according to the following hierarchy:
- Secured creditors with fixed charges (lenders with security over assets)
- Costs of the liquidation (the liquidator’s fees and expenses)
- Preferential creditors (certain taxes and outstanding employee payments)
- Unsecured creditors (suppliers, trade creditors, landlords and contractors)
- Shareholders (they only receive funds once all the creditors are paid)
The liquidator must pay each class of creditor in full before moving on to the next. In practice, that means there is often little, if anything, left for unsecured creditors, who may recover only a small proportion of the money they are owed.
If the liquidator identifies any payments made by the directors that favour certain creditors over others, they can seek to reverse them to ensure all the creditors are treated fairly.
What happens if you make a preference payment during liquidation?
When a company enters liquidation, whether it’s voluntarily or as a result of creditor action, a licensed Insolvency Practitioner (IP) will be appointed to take control of the process and bring the company’s affairs to an orderly conclusion.
One of their key responsibilities is to carefully review all the payments the company made in the run-up to and during insolvency. For ordinary creditors, that usually covers transactions in the six months preceding liquidation. However, for connected parties, such as fellow directors or relatives, the look-back period extends to up to two years.
The liquidator will be looking for payments that:
- Took place when the company was insolvent or during the lookback period
- Improved one creditor’s position over others
- Favoured connected parties
- Fell outside normal business practices
If a transaction meets some or all of these criteria, the liquidator can apply to the court to reverse it. They will then redistribute the funds they recover among the creditors in the correct legal order. If the liquidator cannot recover the money from the creditor, the director who authorised the payment may be held personally liable to repay the sum.
When will a liquidator challenge a preference payment
When a liquidator uncovers a suspicious payment, they will identify the recipient, examine the purpose and assess whether it gave a creditor an unfair advantage. They typically compare the amount received with what the creditor would have been entitled to in a normal liquidation to reveal any imbalance.
For ordinary creditors, it is usually the liquidator’s responsibility to prove that a payment created a preference. However, the burden shifts if you make a payment to a connected party. In this case, the recipient must show that the payment was not intended to create a preference and that they were unaware of the company’s financial position.
How to avoid preference payments during liquidation
Preference payments aren’t always deliberate. They often occur when directors act under pressure or without a full understanding of insolvency rules rather than with the intention of disadvantaging creditors.
Here’s a quick guide to the steps directors can take to avoid preference payments.
- Stop making payments when the company is insolvent
Directors may be tempted to pay a supplier to keep the business afloat a bit longer or make a payment in response to threats of legal action. However, once you suspect insolvency, you should avoid making payments to unsecured creditors altogether. Instead, let the liquidator handle the distributions in a fair and legally compliant way. - Keep detailed financial records
Liquidators can look back at payments made up to two years before insolvency. That’s why it’s important to keep accurate and up-to-date records of payments, invoices and creditor balances. They will help you demonstrate that transactions were part of normal business activity and not examples of preferential treatment. - Communicate clearly with your creditors
Rather than ceasing payments to creditors without explanation, be transparent about the company’s position, keep them informed and reassure them that all payments will be made in accordance with insolvency law. - Document all decisions
If you do make payments to creditors, keep clear written records of your decision-making to help demonstrate that you acted in good faith. However, you should take particular care with payments to connected parties, such as directors, relatives or related businesses, as they will be subject to closer scrutiny and can be more difficult to justify if challenged. - Seek professional advice
Contact a licensed Insolvency Practitioner as soon as you suspect the company may be insolvent. They will help you understand your options, protect your position and guide you on how to avoid risks such as preference payments and wrongful trading.
We’re here to help
If you’re worried about preference payments and are considering liquidating your company, contact us early. We can assess your company’s finances, explore your options and guide you on the most appropriate route forward while protecting your position. Get in touch today for a free and confidential consultation or arrange a meeting at one of our 100+ UK offices.
