Preferences are often paid not to help the creditor but to release someone else. Section 346 of the Companies Act 1997 follows the money to the person who really benefited.
Section 346 — the guarantee problem
This section applies where a company is in liquidation and a transaction of the company —
(a) is voidable under section 340; and
(b) has had the effect of discharging, to the extent of a particular amount, a liability — whether under a guarantee or otherwise, and whether contingent or otherwise — of a related entity of the company.
The liquidator may, by proceedings in a court of competent jurisdiction, recover that amount from the related entity as a debt due to the company.
Take the common case. A director personally guarantees the company’s overdraft. In the last months before liquidation the company pays the bank down. The bank may well have the section 340 defence — good faith, ordinary course of business, no reasonable grounds for suspicion — so the liquidator cannot recover from it.
But the director’s guarantee exposure has been reduced by exactly the amount paid, using the company’s money, at the expense of the other creditors. Section 346 makes the director pay that amount to the liquidator, whether or not the bank is liable.
Note the words “whether under a guarantee or otherwise and whether contingent or otherwise”. Any liability of the related entity that the transaction discharged is caught — an indemnity, a co-obligation, an unsecured advance the related entity would have had to fund.
(a) a person who was, at the time of the transaction, a director of the company, or a nominee or relative of, or a trustee for, or a trustee for a relative of, a director; or
(b) a person, or a relative of a person, who had control of the company; or
(c) another company controlled by a director, or by a nominee, relative or trustee of the kind in paragraph (a); or
(d) another company that was a related company.
(3) In deciding what orders to make under section 341 on an application relating to the transaction, the Court shall take into account any amount recovered under subsection (2).
(4) Where the liquidator recovers from the related entity, that entity has the same rights — by way of indemnity, subrogation, contribution or otherwise, against the company or anyone else — as if it had itself paid the amount in discharging the liability.
So the guarantor who repays the liquidator is restored to the position of a guarantor who has paid: it may claim against the company in the liquidation, and pursue any co-guarantor for contribution.
Section 349 — a holding company’s liability for its subsidiary
(a) a subsidiary of the company incurs a debt; and
(b) at that time, the subsidiary does not satisfy the solvency test, or becomes unable to satisfy it as a result; and
(c) at that time, there are reasonable grounds for believing that; and
(d) either (i) the company, or one or more of its directors, is or are aware at that time that there are grounds for so believing; or (ii) having regard to the nature and extent of the company’s control over the affairs of the subsidiary, and any other relevant circumstances, it is reasonable to expect that (A) a company in its circumstances would be so aware, or (B) one or more of such a company’s directors would be.
On the application of the liquidator of the subsidiary or the person to whom the debt is owed, where the Court is satisfied that (a) the section applies, (b) the creditor has suffered loss or damage in relation to the debt because of the liquidation of the subsidiary, and (c) the debt was wholly or partly unsecured when the loss was suffered, the Court may declare that an amount equal to the loss or damage may be recovered from the company as a debt due to the subsidiary or the person, as the case may be.
A holding company cannot escape by keeping itself uninformed. Where it exercises control over the affairs of the subsidiary, the Court asks what a company in its position would have been aware of. The greater the control, the harder it is to say the parent did not know.
Note also who may apply: the creditor itself, not only the liquidator. A supplier left unpaid by a subsidiary can proceed directly against the parent, and the recovery may be ordered as a debt due to that person.
The structure mirrors section 348, which imposes the same liability on a director of the company that incurred the debt.
The group recovery provisions compared
| Provision | What must be shown | Look-back | Who recovers |
|---|---|---|---|
| s 346 | A voidable s 340 transaction that discharged a related entity’s liability | The s 340 specified period — 1 year | The liquidator, as a debt due to the company |
| s 349 | A subsidiary incurred a debt when it failed the solvency test, with awareness or reasonable expectation of awareness | No fixed period | The liquidator of the subsidiary or the creditor |
| s 344 | Acquisition from, or disposal to, a related party at inadequate or excessive value — no insolvency needed | 5 years | The liquidator |
| ss 320A–320C | Just and equitable on the s 320C factors — management, conduct towards creditors, causation | No fixed period; reaches a company that has been related | The liquidator, a creditor or a shareholder |
| s 345 | A charge to an officer or associate enforced within 6 months without leave | Charge created while, or within 6 months after, the person was an officer | The charge is void |
- For a liquidator: before conceding a section 340 defence to a bank or major creditor, check whether the payments reduced a guarantee. Section 346 may produce a full recovery from the guarantor even where the creditor is safe.
- For a director who has guaranteed company debt: paying the guaranteed creditor ahead of others in the run-up to a liquidation creates personal exposure under section 346, and the section 340(4) exclusion means the company’s intention to protect you is irrelevant.
- For a holding company: the greater the control exercised over a subsidiary, the greater the section 349 risk. Where a subsidiary is in difficulty, either stop it incurring debt or fund it properly.
- For a creditor of a group subsidiary: section 349 is a direct claim. But note section 320C(3) — simply relying on the relationship is not a ground for a pooling or contribution order, so a guarantee remains the better protection.
Sources
- Companies Act 1997 — ss 4, 5–7, 320A–320C, 340, 341, 344, 345, 346, 348, 349
Before relying on anything here, read the current text of the Companies Act 1997 and check for later amendments. If a decision matters to you, get advice — start with the Office of the Public Solicitor, or find a firm in the law firms directory.