To ensure all creditors are treated fairly when a business is insolvent, liquidators are empowered by law to look back at the transactions of the company conducted before the commencement of winding up. More importantly, they may set aside transactions where one of the creditors was ‘unfairly preferred’.

What is “Unfair Preference”?

This includes situations where a debtor decides to enter into a particular transaction or to repay a particular creditor, or carries out any other act which puts the particular creditor in a better position than other creditors. The law does not require commercial dishonesty in the form of an intention to prefer. The test for unfair preference is whether the decision is influenced by a desire to improve the creditor's position in the event of insolvent liquidation (s50(4) of the Bankruptcy Ordinance (“BO”)).

There is a related discussion in our earlier newsletter: “Unfair Preference to Non-associates” published in May 2008. Please click on the following link to read our earlier article: https://www.onc.hk/en_US/publication/unfair-preference-to-non-associates

Who are the ‘associates’ of the debtor?

s51B of the BO provides an extensive definition of ‘associates’. In case of personal insolvency, an ‘associate’ of the debtor includes the debtor’s spouse, relatives, and the debtor’s spouse’s relatives. However, in case of corporate insolvency, s266B(1)(b) of the Companies Ordinance has also directed the meaning of ‘associates’ to s51B of the BO, i.e.: a person is an ‘associate’ of a company if he:

1.       is in partnership with the company; or

2.       employs or is employed by the company (directors and other officers are treated as employees under this provision); or

3.       is a trustee of a trust and the beneficiaries of the trust include, or the terms of the trust confer a power that maybe, exercised for the benefit of, the company or an associate of the company.

However, a “debtor” referred in s51B of the BO cannot mean the director of an insolvent company. Therefore, the spouse/ relatives of a director do not come within the meaning of ‘associates’ of the insolvent company.

The implication of being an ‘associate’ is two-folded. Firstly, pursuant to s50(5) of the BO, there is a rebuttable presumption that the debtor was influenced by the aforementioned desire.  Secondly, pursuant to s50(1)(b) of the BO, the relevant time period during which the unfair preference can be set aside is extended from the normal 6-month period to 2-years prior to the date of the presentation of the bankruptcy petition against the debtor.

Commercial considerations and moral pressure to give preference differs from a “desire” to prefer

In Re Fairway Magazines Ltd, Fairbairn v Hartigan [1993] BCLC 643, the Court held that Fairbairn (the director of the insolvent company) had shown that the decision to grant a charge to himself in consideration for a loan was not influenced by a desire to prefer himself but the company was solely influenced by commercial considerations. It had been shown that there was a need to raise money from a source other than the bank in order to carry on business.

In Joint and Several Trustees of Property of Hau Po Man v Hau Po Fun & Anor [2005] 2 HKLRD 262, the Court held that the bankrupt in deciding to make the transfer of the share to his sister and the car to his sister’s husband was not an unfair preference as the bankrupt was motivated by a desire to put an end to the disruption to his professional practice caused by his sister’s husband’s visits and to preserve his family ties with his relatives. There is no distinction between commercial and moral pressure, both can remove the relevant desire. The Court’s relevant consideration is that the pressure has the effect of causing the person upon whom the pressure is applied to perform the act in question.  

Unfair transactions may be challenged

The onus is on the ‘associates’ to rebut the presumption that the debtor was influenced by the aforementioned desire.

In the event that the Court finds a transaction involves an unfair preference, the Court may make such order as it thinks fit. Pursuant to s51A(1) of the BO, the orders may include:

1.       vesting the property in connection to giving an unfair preference in the liquidator;

2.       directing any person to pay to the liquidator any benefits received from the debtor; and

3.       allowing proof of debts from persons who are affected by the such orders.

It should be noted the orders specified are quite wide. The main aim of the law is to restore the position to what it would have been if the debtor had not given the unfair preference. As the Court’s order can affect property acquired by third parties, the law also provides protection to persons who have acquired the property or benefit in good faith and for value.