When to report a preference in a debt relief order application

Schedule 4ZA of the Insolvency Act 1986 sets out the conditions for making a debt relief order.

Paragraphs 1 to 8 set out the mandatory grounds. The debtor must meet the mandatory grounds for the DRO application to be approved.

Undervalue transactions and preferences

Para 9 (undervalue transactions) and para 10 (preferences) are the grounds on which the Official Receiver has the discretion to accept or decline an application.

What is a preference payment in a DRO?

A preference has taken place if the debtor has made a payment to a qualifying debt during the period between the start of the period of two years ending with the application date, and the determination date.[1]

A preference is a payment towards a qualifying debt, or doing something (or suffering something to be done) that puts that creditor in a better position.

Key considerations

The Official Receiver can only look back over the two years before the application. Where there is a strong chance the application may be declined as a result of a preference it may be appropriate to consider delaying the application

A preference can only be paid in respect of a qualifying debt. A payment towards an excluded debt does not count, as they cannot be put in a better position.

Payment towards a debt does not count as a preference if the debt is not payable immediately or at some certain future time. This would seem to rule out preferences being paid in respect of time-barred debts or otherwise unenforceable debts. It might be necessary to consider whether an undervalue transaction has taken place in these circumstances.

Payments made by third parties from their own funds directly to creditors are not considered to be preferences.

The Insolvency Act 1986 provides no guidance to the Official Receiver about the factors it should consider when deciding whether to accept or decline an application in light of any preferences that have been paid.

In bankruptcy, the law on preferences operates to enable the bankruptcy trustee to recover monies that have been paid as preferences for the bankruptcy estate.

There are no provisions for the Official Receiver to attempt such recoveries after a DRO has been made. The only question is whether or not a DRO should be made in light of any preferences that have been paid.

Intention to prefer in bankruptcy

There are similarities between the definition of a preference in bankruptcy and the DRO definition[2] One important difference is that, in bankruptcy, there is a requirement that the person paying the preference intended to put the person they paid in a better position.

Intention is not a factor in determining if a preference has been paid in relation to a DRO but the Official Receiver can take it into account when deciding if the application should be declined.

When considering preferences in DRO applications, intermediaries can apply a two-stage test:

1. Has a preference been paid and does it need to be reported?

2. Is it likely the DRO application will be declined as a result of the preference and what information or evidence might the client submit to reduce the chances of this?

Has a preference been paid

The first stage is deciding if a preference has been paid and if so, must it be reported.

The definition of a preference in Schedule 4ZA is so wide that most people who apply for a DRO have paid a preference. A debtor would make strict pro-rata payments to all their creditors in the two years before the application for it to never apply. Specific guidance from the Official Receiver, and general practice, indicates a degree of judgement on the part of the approved intermediary.

The starting point is to consider the possible preference with reference to the law and any specific guidance that has been published. After that, it is a case of the intermediary making a professional judgement.

The Official Receiver does not usually advise about specific cases. It is the approved intermediary's decision whether the payments need to be reported as preferences.

The Official Receiver has advised that if an approved intermediary is in doubt about reporting a preference, they should report it. Shelter's Specialist Debt Advice Service advice on specific cases will tend to be cautious in this regard, and an adviser may wish to bear this in mind before contacting the consultancy service.

Where a preference is being reported on the application, it is appropriate to advise the debtor there is a risk the application will be declined.

Will the application be declined

The second stage of the test is whether the DRO application will be declined as a result of the preference.

Although the ‘intention’ to prefer is not part of the definition of a preference in relation to DROs, it is likely to be a crucially important factor for the Official Receiver in their determination of whether the application should be accepted or declined.

Declined applications due to preference payments most commonly involve the DRO applicant having paid family or friends.

There are several other factors the Official Receiver considers. The DRO Guidance for Advisers suggests intermediaries consider:

• whether the debtor was insolvent when they made the payments

• why they made the payments

• who they made the payments to

• what date they made the payments and how much they paid

• whether there was any agreement drawn up for the payments

• why the debtor did not distribute the funds to all of their creditors evenly

• whether there was any creditor pressure

• whether a preference has been made to an associate (like a relative)

• whether there is any evidence that the funds repaid were owed

• how the debtor got the funds they needed to make the payments

Any evidence positively addressing these points (supplied with the application or in a preceding email) may help to improve the chances of the application being accepted.

Where a preference has been identified, depending on the details, it may be necessary to consider whether this might lead the OR to consider whether a Debt Relief Restrictions Undertakings and Orders (DRRU/O) is appropriate.

These are provided for by Schedule 4ZB IA 1986. They may be considered where the client has acted dishonestly or irresponsibly and can extend the period over which the DRO restrictions apply for up to fifteen years.