31 Oct 2018

Unreasonable director-related transactions


5 min

No insolvency prerequisite and limited defences puts liquidators in prime position.

Liquidators will examine whether the company being wound up entered into any transactions that reduced the amount of assets available for distribution to creditors in the liquidation. One type of transaction that liquidators look for in the company records are those that can be characterised as being an ‘unreasonable director-related transaction’ under section 588FDA of the Corporations Act 2001. This recovery option is only available to liquidators and is an underutilised but powerful tool to unwind particular transactions.

This article looks at the following elements:

  • What is the basis of the claim.

  • How the recovery value is calculated.

  • How ‘unreasonable’ is tested.

  • Within what period the transaction must occur.

  • What other criteria applies.

If a claim is established, the value or the asset pertaining to the unreasonable director-related transaction is required to be paid or returned to the liquidator.

Basis of claim
A liquidator must prove that:

  1. a transaction was entered into

  2. a director or close associate of the director was involved in the transaction

  3. company would not have entered into the transaction considering the benefits (if any) and detriment to the company.

The transaction must involve the company and can be a payment; a transfer or disposition of property; a security or incurring an obligation or commitment to make a payment, disposition or issue. Section 588FDA is designed to cover money or assets leaving the company, or commitments (like security interests) being made over money or assets.

The recipient must be a director, close associate, or a person on behalf or for the benefit of a director of close associate. A Director is defined under section 9 of the Corporations Act and includes those not formally appointed but act in the position of a director. Close associates can be the relative/de facto spouse of a director—or even a relative of that spouse/de facto.

However, the Victorian Court of Appeal in Vasudevan v Becon Constructions (Australia) Pty Ltd [2014] VSCA 14 widened the potential for a related entity to be caught under this provision. Click here to read our article that discusses this in detail.

How the recovery value is calculated
The liquidator must have regard to the benefits (if any) and detriment to the company and other parties, and any other relevant matter the liquidator considers appropriate. Typically, the liquidator would first look for a reduction in the net position of company assets caused by the transaction to determine whether it is reasonable or not. The other factors are then considered to form the final view.

The liquidator will recover the difference between the value given by the company and the value received by the company. Only the excess between the two values is recoverable. A simple example is where an asset is sold for undervalue.

How ‘unreasonable’ is tested
The court applies the ‘reasonable person test’ to consider the transaction from the view of a ‘reasonable person’ in the company’s circumstances. This person has knowledge of the company’s financial position, who is not trying to gain a personal benefit, or give a benefit to anyone else, or cause a loss to the company. A reasonable person is assumed to not enter into a company transaction that would cause detriment to the company or reduce its assets.

Within what period the transaction must occur
Transactions that have occurred four years before the ‘relation-back day’ (i.e. the date when the winding up is taken to have begun) can be put under the microscope. The ‘relation-back day’ is established in the following appointment types as being:

  • A liquidation that follows a voluntary administration—date of administrators being appointed (regardless of whether a DOCA was in effect during the intervening period).

  • A court appointment—date of the application being filed.

A creditors’ voluntary winding up—date of the members’ meeting that resolved to wind up the company.

What other criteria applies
One of the key benefits of this action is that a liquidator does not have to prove that the company was insolvent at the relevant time—only that it was an unreasonable transaction.   Further swaying the balance of power to the liquidator is the fact that the statutory defences of no knowledge of insolvency and acting in good faith cannot be used to defend this type of action. Liquidators have three years to make a formal claim—not merely a demand—after the relation-back day.

Due to the narrow scope of who can be pursued under this section, this type of claim is not as common as uncommercial transactions or unfair preferences. However, when a claim is identified, given the benefits of not having to prove insolvency and the limited defences available to the recipient, a liquidator is placed in a strong position to pursue and recover these claims for the benefit of creditors.

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