Unreasonable Director Related Transactions

What is an Unreasonable Director Related Transaction?

Liquidators investigate transactions when they believe that they were not beneficial to the company, particularly when they involve parties related to the company. The Corporations Act sometimes will require the other party to the transaction to return an asset or make a payment to the liquidator.

An unreasonable director related transaction is one that involves a director or close associate (as defined) and whether there was no benefit to the company.

Who recovers a director related transaction?

Only liquidators may seek to recovery unreasonable director related transactions. The procedure is not available to provisional liquidators, voluntary administrators, deed administrators or controllers.

What needs to be shown?

The liquidator must show that:

1. a transaction was entered into;
2. a 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.

Why recover an unreasonable director related transaction?

One of a liquidator's functions is to discover whether the company entered into a transaction that reduced the amount of assets that are available for distribution in the winding up. If that occurred, the liquidator will seek recovery to make a more equitable distribution of the company's assets to its creditors.

What may be recovered?

The liquidator can recover the difference between what was provided by the company and the value that a reasonable person in the company's circumstances would have provided. Only an 'excess' is recoverable.

The elements of unreasonable director related transactions

1. The transaction

There must be an transaction involving the company that was 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.

2. A director or close associate

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 other 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: (1) a relative or de facto spouse of a director, or (2) 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.

3. The reasonableness of the transaction

The company must benefit from the transaction for it to be reasonable. If the benefits of the transaction are outweighed by the detriment, it will be unreasonable. The liquidator will look for a reduction in the net asset position of the company caused by the transaction to determine whether it is reasonable or not.

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, who has knowledge of the financial position of the company, and 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 causes a detriment or reduction in assets to the company.

4. The time period

An unreasonable director related transactions 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 recognized day on which the liquidation legally commenced. There are three possibilities.

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 about 3 weeks before the Order, but may vary.
3. For a creditors voluntary winding up - it is the date of the members' meeting resolving to wind up the company.

5. Insolvency of company

The company does not need to have been insolvent at the date of the transaction, or to become insolvent because of the transaction, for a transaction to be an unreasonable director related 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 - is not relevant. In fact it is 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 benefit of the transaction. The whole transaction is not voided, unless there was no reasonable part to it. In this case recovery 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. An extension to this limit may be granted by the Court, but the application for that extension has to be made within the 3 year period and the liquidator will need a good reason for the delay in making the claim.

Disclaimer
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.

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Last Updated: 7.2.2008