Unfair Preference

An unfair preference (or "voidable 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:

1. 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)
2. the person or company then went into bankruptcy within a specified time thereafter, usually referred to as the vulnerability period
3. the payment had the effect of putting the creditor in a better position than other unsecured creditors
4. 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 creditors 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 creditors.

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.