The concept of a ‘benefit’, and what is ‘unreasonable’, may seem straightforward in a commercial setting.
For example, refraining from unreasonably drawing company funds to buy personal luxury items. However, under section 588FDA of the Corporations Act 2001, the scope of what constitutes an unreasonable director-related transaction is broader than what most realise, and importantly, it reaches beyond direct benefits to indirect benefits.
This distinction is crucial for both directors and advisors. Regardless of whether you’re an accountant who has been approached to give the okay for a client’s transaction, or a solicitor considering a client’s potential exposure under a transaction, understanding what falls within the scope and net of section 588FDA can mean the difference between a regular transaction and one that could be chased by a liquidator.
What is an unreasonable director-related transaction?
The unreasonable director-related transaction provisions are contained within section 588FDA of the Corporations Act 2001 and are one of the many antecedent transaction provisions available to a liquidator to claw back funds in a liquidation. Broadly speaking, section 588FDA allows a liquidator to set aside a transaction if:
A company makes a payment, transfers property, or otherwise provides a benefit to a director (or a close associate of a director); and
A reasonable person in the company’s circumstances would not have entered into the transaction, considering the terms, benefits and detriments to the company.
Significantly, the legislation does not confine what constitutes a benefit to only cash payments or direct transfers of assets. The term is open to be broadly interpreted, encompassing anything of value or advantage, whether tangible or intangible.
The case of Vasudevan v Becon Construction
The concept of what constitutes a benefit was considered in the matter of Vasudevan v Becon Constructions (Australia) Pty Ltd[1], a leading authority on how the term can be broadly interpreted under section 588FDA. The case confirmed that section 588FDA may capture benefits that are not only direct, but also indirect, contingent, or derivative in nature.
The facts of this case were relatively simple:
Mr Thompson was the sole director and shareholder of three entities - Wulguru Retail Investments (Wulguru), Richmond Commercial (RC), and Mulgrave Commercial (MC).
RC and MC were indebted to their creditor, Becon Constructions (Becon). These debts had been personally guaranteed by Mr Thompson.
RC and MC eventually defaulted on their debts, and Becon had initiated proceedings against Mr Thompson in respect of the guarantee he had provided. At this time, Wulguru did not have any direct liability to Becon.
Subsequent to the defaults of RC and MC and the proceedings against Mr Thompson, a deed was executed by which:
Wulguru assumed joint liability for the debts owed by RC and MC;
Wulguru granted a mortgage to Becon to secure the performance of its obligations under the Deed; and
Becon agreed not to proceed with litigation against Mr Thompson and released him from the various liabilities arising from under his personal guarantees.
Wulguru was later placed into liquidation, and the appointed liquidators sought to challenge the deed pursuant to section 588FDA. The liquidators argued that:
Wulguru did not receive any commercial benefit by entering into the deed; and
Whilst the transaction directly secured the obligations of RC and MC, Mr Thompson had also benefitted as the deed served to relieve his personal exposure to the guarantees that he had provided previously.
The deed, and the mortgage provided by the deed, was declared void by the court. The outcome confirmed that section 588FDA serves to capture arrangements that indirectly benefit a director (or related parties), even in instances whereby the recipient of a transaction is a third-party and the benefit provided to the director is contingent or derivative.
Key Takeaways
The test under section 588FDA isn’t just about whether the transaction was generous in hindsight, but also whether it was objectively and commercially sound at the time, having regard to the circumstances of the company. If the general inclination is no, then there is a possibility that the transaction could be clawed back, considering significant risk to the director and/or related parties.
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[1] [2014] VSCA 14
