Director Related Transactions
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What is an unreasonable director related transaction?
A transaction is an unreasonable director related transaction if it involves a director or close associate (as defined) of the company and had no or little benefit to the company (i.e. it was unreasonable for the company to enter into the transaction). The Corporations Act sometimes will require the other party to the transaction to return an asset or make a payment to the liquidator.
Who recovers an unreasonable director related transaction?
Only liquidators may seek to recovery of these transactions. These claims are not available to provisional liquidators, voluntary administrators, deed administrators or controllers.
What needs to be proved to make the claim?
To make a claim the liquidator must prove that:
1. a transaction was entered into;
2. a director or close associate of the director was involved in the transaction; and
3. either there was no benefit to, or there was a detriment to, the company by entering into the transaction.
Why recover an unreasonable director related transaction?
One of a liquidator's functions is to examine whether the company entered into any transactions that reduced the amount of assets that otherwise would have been available for distribution to creditors in the winding up. If there are such transactions, the liquidator will seek recovery of the assets transferred or the payment of money in compensation in order to make a more equitable distribution to creditors.
What amount may be recovered?
The liquidator may recover the difference between the value that was provided by the company in the transaction and the value of consideration that was given to the company in the transaction. Only the excess between the two values is recoverable.
What are the main elements of unreasonable director related transactions?
1. The transaction - There must be a transaction involving the company. It may have been a payment, a transfer or disposition of property, the issue of securities, or incurring an obligation or commitment to make a payment, disposition or issue. The section is designed to cover money or assets actually leaving the company, or commitments like security interests being made over money or assets of the company.
2. The payment, disposition or issue must involve one of a few parties related to the company, or more correctly, the director of the company. One of the parties to the transaction must be either a:
(i) a director of the company,
(ii) a close associate of a director of the company, or
(iii) a 'nominee' person acting on behalf of or for the benefit of a director or their close associate.
This third class of people has been added to stop a director related party disguising their involvement by including another person in the transaction, but where the related party still receives the benefit of the transaction.
Who is a director?
A director is defined as someone that:
(i) is appointed to the position of a director; or
(ii) is appointed to the position of an alternate director and is acting in that capacity;
regardless of the name that is given to their position; and
(b) unless the contrary intention appears, a person who is not validly appointed as a director if:
(i) they act in the position of a director; or
(ii) the directors of the company or body are accustomed to act in accordance with the person's instructions or wishes.
Who is a close associate?
A close associate is either a relative or de facto spouse of a director, or a relative of a spouse or of a de facto spouse of the director. A relative is a spouse, parent or remoter lineal ancestor, son, daughter or remoter issue, or brother or sister of the person. Essentially it is a family (including de facto family) member.
Why would a transaction be seen as unreasonable?
The company must benefit from a transaction for it to be reasonable. If the benefit accruing to the company is outweighed by the detriment or costs to the company, it will be unreasonable for the company to have knowingly entered into the transaction. To determine whether it is reasonable or not, the liquidator will examine whether there has been a reduction in the net asset position of the company caused by the transaction.
What is a reasonable person test?
The Court will look at the transaction from the eyes of a reasonable person in the company's circumstances. A reasonable person is someone who has knowledge of the financial position of the company, who is not trying to gain a personal benefit or give a benefit to anyone else, or cause a loss to the company. It may be assumed that a reasonable person would not enter into a transaction that would cause a detriment to or reduction in the assets of the company.
What time period is involved?
An unreasonable director related transaction must have been entered into within 4 years before the relation back day, or between the relation back day and the appointment day. The relation back day is the day on which the liquidation legally commences. There are three possible relation back days:
1. For a liquidation that followed a voluntary administration - it is the day that on which the administrators were first appointed to the company, even if a deed of company arrangement was in effect in the intervening period.
2. For an official liquidation (a court appointment) - it is the day on which the application was filed. This is usually a few weeks before the Order.
3. For a creditor's voluntary winding up - it is the date of the members' meeting resolving to wind up the company.
Does the company need to be insolvent at the time of the transaction?
No. The company does not need to have been insolvent at the date of the transaction, or have become insolvent because of the transaction. This also means that the statutory defences available to parties in other recovery actions - the defence of good faith and no reasonable grounds to suspect insolvency - are not relevant. In fact they are specifically excluded.
What relief is available to the liquidator?
Recovery applications are limited to a relief available under section 588FF, but these cover almost every practical option. The most common relief sought is the return of the monies or assets received by the other party. In this case however, recovery is limited to the excess, or the unreasonable part of the transaction. The whole transaction is not voided, unless there was no reasonable part to it. Therefore a relief is generally the payment of money.
How long does the liquidator have to make a claim?
Claims must be made within 3 years after the relation back day. That is, an application for recovery must be filed within that 3 year period. It is insufficient for the liquidator to only have issued a demand within that period.
For more detailed information:
Insolvency Resource Page: Unreasonable Director Related Transactions
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information
provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.
Last Updated: 07.02.2011
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