Fiduciary Obligations of Subsidiary Directors Operating near Corporate Insolvency
Subsidiary directors must prioritize creditor asset preservation over parent commands immediately upon detecting potential balance sheet or cash flow illiquidity.
Preferential Payments
Meaning
A category of financial transfers made to specific creditors shortly before a bankruptcy filing is subject to reversal by a court-appointed trustee. Recovering preferential payments ensures that all unsecured creditors are treated equally according to the law during liquidation. This rule prevents a failing company from favoring certain suppliers or insiders over others.
Trustees analysis
Trustees analyze the company ledgers to identify payments made outside the ordinary course of business during the pre-insolvency period. The reversal of preferential payments forces the favored creditor to return the cash to the bankruptcy estate for redistribution. This clawback mechanism protects the general pool of creditors.
Suppliers defense
Suppliers can defend themselves against clawbacks by showing that the payments they received matched their historic billing and payment patterns. To avoid being categorized as preferential payments, transactions should occur under normal terms and without unusual pressure from the creditor. This defense requires detailed documentation of prior trading history.
If the payments are proven to be routine, the supplier is allowed to keep the cash and continue supporting the restructured business.
The length
The length of the look-back period varies depending on whether the recipient of the cash was an independent supplier or an insider. In many jurisdictions, the window for analyzing preferential payments is longer for transactions involving directors and parent companies. This extended window ensures that insider actions are scrutinized closely.