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Unreasonable Director Related Transactions

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Introduction

Major Headings

Reasons for recovering Unreasonable Director-Related Transactions
Elements of an Unreasonable Director-Related Transactions

The Transaction
Director or Close Associate
The reasonableness of the transaction

Timing of transaction
Insolvency of company
Orders available to the liquidator
Timetable for claims

Overview

Liquidators will investigate transactions when they believe that they were either not beneficial to, or was detrimental to, the company. This is particularly so when those transactions involved parties related to the company. These particular transactions are called unreasonable director-related transactions. The Corporations Act sometimes will void the transaction and require that the other party to the transaction return an asset or make a payment to the liquidator.

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

The other party to the transaction does not have to be a creditor of the company. The transaction just needs to be to, or for the benefit of, a director or close associate of a director of the company.

To make a recovery of an unreasonable director-related transaction, the liquidator must show that:

1. a transaction was entered into;
2. a close associate of the director was involved or received a benefit; and
3. either there was no benefit to or there was a detriment to the company.

This paper contains links to legislation. These will open in a separate window. Most of the legislation shown in this paper is only a summary or extract of the entire section. The links go to the entire section.

Reasons for recovering Unreasonable Director-Related Transactions

One of a liquidator's functions is to ensure that all of the company's assets are available for distribution to creditors. Part of that role is to discover whether the company entered into any transaction that reduced the amount of assets that are available for distribution in the winding up. The liquidator will want to recover these assets.

The provisions detailed in this paper give the liquidator the power to recover monies or assets paid or transferred in an unreasonable director-related transaction. But the liquidator can only recover the difference between the reasonable value provided by the company and the value provided by the other party to the transaction. The total transaction is not voided, only an 'excess' of consideration is recoverable.

Elements of Unreasonable Director-Related Transactions

A liquidator must prove a number of points in order to make a claim under these provisions. These claims may be broken down into three significant parts.

1. There must have been a transaction between the company and other parties. Something must have passed from the company or the company must have become obligated in some manner;
2. That other party must have been a director of the company or a close associate of a director of the company as defined by the Corporations Act; and
3. The transaction must be one that a reasonable person in the company's position would not have entered into under those circumstances or for the amount of consideration received.

The Transaction

There must be a transaction between parties. To be an unreasonable director-related transaction, the transaction must be a payment made by the company, a transfer or disposition of property of the company, the issue of securities by the company (an obligation over an asset), or the 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 placed over money or assets owned by the company. This means that transactions may fall under this section even if no asset physically leaves the control of the company.

CORPORATIONS ACT 2001 - SECT 588FDA
Unreasonable director-related transactions
(1) A transaction of a company is an unreasonable director related transaction of the company if, and only if:
(a) the transaction is:
(i) a payment made by the company; or
(ii) a conveyance, transfer or other disposition by the company of property of the company; or
(iii) the issue of securities by the company; or
(iv) the incurring by the company of an obligation to make such a payment, disposition or issue; and

Further, the transaction does not need to be voluntarily made by the company. Transactions may be caught under this section even if they were ordered to be done by the court. This provision will stop the parties arranging a consent court order to validate a transaction. It will also catch transactions that have not been arranged, but would still be unreasonable to the reasonable person.

CORPORATIONS ACT 2001 - SECT 588FDA
Unreasonable director-related transactions
(3) A transaction may be an unreasonable director related transaction because of subsection (1):
(a) ..
(b) even if the transaction is given effect to, or is required to be given effect to, because of an order of an Australian court or a direction by an agency.

In summary, the section is designed to capture any type of transactions where the company did not received fair or reasonable compensation for something of value that was passed to another party.

Director or Close Associate

To fall under this section, the payment, disposition or issue (the transaction) must involve one of a few parties related to the company, or more correctly, the director of the company. At least one of the other parties in 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 or related party disguising their involvement by including another person in the transaction, but where they still receive the benefit of the transaction themselves.

CORPORATIONS ACT 2001 - SECT 588FDA
Unreasonable director-related transactions
(b) the payment, disposition or issue is, or is to be, made to:
(i) a director of the company; or
(ii) a close associate of a director of the company; or
(iii) a person on behalf of, or for the benefit of, a person mentioned in subparagraph (i) or (ii); and ..

A director is defined in the Corporations Act 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.

A close associate is defined as:

(1) a relative of a director; or
(2) a relative of a spouse (see below) 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. A spouse of a person also includes a de facto partner of the person within the meaning of the Acts Interpretation Act 1901. The director, close associate or relative does not also have to be a creditor of the company, just involved in the transaction.

CORPORATIONS ACT 2001 - SECT 588FDA
Unreasonable director-related transactions
(3) A transaction may be an unreasonable director related transaction because of subsection (1):
(a) whether or not a creditor of the company is a party to the transaction;

If no other party to the transaction falls within the definition of close associate, these provisions cannot be used. However, the transaction may be void under other provisions of the Act.

The reasonableness of the transaction

To be unreasonable, the benefits of the transaction (if any) to the company must be outweighed by the cost or detriment to the company. There must be no commercial benefit to the company from entering into the transaction. In cases where assets are sold or transferred, unless they are sold or transferred for their true value and the price is recoverable, there will be no or not sufficient benefit to the company. If they are sold for less than their true value, there will be a detriment.

In some cases the consideration given on sales of goods or services provided by the company is nominal and, therefore, uncommercial. In some cases money is intentionally dissipated from the company through it purchasing assets or services at inflated prices, (i.e. excessive prices compared to the value of the asset or service provided). Payments may be made for personal liabilities or to the benefit of other parties, and these will usually be of no commercial benefit to the company. All of these transactions will be detrimental to the company.

It does not matter whether the transaction is a sale or purchase by the company, or any other form of transaction. The liquidator will be looking for a reduction in the net asset position of the company caused by the transaction.

CORPORATIONS ACT 2001 - SECT 588FDA
Unreasonable director-related transactions
(c) it may be expected that a reasonable person in the company's circumstances would not have entered into the transaction, having regard to:
(i) the benefits (if any) to the company of entering into the transaction; and
(ii) the detriment to the company of entering into the transaction; and
(iii) the respective benefits to other parties to the transaction of entering into it; and
(iv) any other relevant matter.

The Reasonable Person Test

The test of whether the transaction is appropriate is one of a reasonable person in the company's position. It may be assumed that a reasonable person would not enter into a transaction that causes a detriment or reduction of assets to the company. What is a reasonable person in the circumstances? The short answer is, the court will decide.

But the court will look at the transaction from the point of view of an independent person, that has knowledge of the financial position of the company and who is not trying to gain any personal benefit or give a benefit to anyone else, or cause a loss to the company. If that reasonable person would have entered into the transaction given the circumstances and the consideration received, the transaction is not likely to be unreasonable.

A transaction is only unreasonable if a reasonable person in the company's circumstances would not have entered into the transaction having regard to:

(i) the benefits (if any) to the company of entering into the transaction, and
(ii) the detriment to the company of entering into the transaction.

The circumstances of the transaction must be examined at the time when the transaction is entered into, not at the time when any obligation related to the transaction was originally incurred. The relevant circumstances apply at the time when the company actually makes a payment or disposition, rather than when it became committed to do so. This is the same proposition that applies to preferential payments and insolvency, where insolvency is considered when the money was paid, not when the debt was originally incurred.

CORPORATIONS ACT 2001 - SECT 588FDA
Unreasonable director-related transactions
(2) To avoid doubt, if:
(a) the transaction is a payment, disposition or issue; and
(b) the transaction is entered into for the purpose of meeting an obligation the company has incurred;
the test in paragraph (1)(c) applies to the transaction taking into account the circumstances as they exist at the time when the transaction is entered into (rather than as they existed at the time when the obligation was incurred).

Timing of transaction

Section 588FE deals with unreasonable director-related transactions and their timing. The transaction in question must have been entered into in the period staring 4 years before the relation back day and ending when the winding up began.

CORPORATIONS ACT - SECTION 588FE
Voidable transactions
(6A) The transaction is voidable if:
(a) it is an unreasonable director related transaction of the company and
(b) it was entered into, or an act was done for the purposes of giving effect to it:
(i) during the 4 years ending on the relation back day; or
(ii) after that day but on or before the day when the winding up began.

The relation back day is the recognized day on which the liquidation commenced. This date is important when determining whether a transaction occurred within the relevant time period. There are three possibilities.

1. For an official liquidation (a court appointment) - it is the day on which the application to wind up the company was filed with the court. This is usually about 3 weeks before the Order.

The legislation as it relates to official liquidation's states:

CORPORATIONS ACT 2001 - SECT 513A
Winding up ordered by the Court
If the Court orders under section 233, 459A, 459B or 461 that a company be wound up, the winding up is taken to have begun or commenced:
(a) if, when the order was made, a winding up of the company was already in progress—when the last-mentioned winding up is taken because of this Division to have begun or commenced; or
(b) if, immediately before the order was made, the company was under administration—on the section 513C day in relation to the administration; or
(c) if:

(i) when the order was made, a provisional liquidator of the company was acting; and
(ii) immediately before the provisional liquidator was appointed, the company was under administration;

on the section 513C day in relation to the administration; or
(d) if, immediately before the order was made, a deed of company arrangement had been executed by the company and had not yet terminated—on the section 513C day in relation to the administration that ended when the deed was executed; or
(e) otherwise—on the day when the order was made.

2. For a creditor's voluntary winding up - it is the date of the members' meeting resolving to wind up the company.

The provisions as they related to voluntary windings up are:

CORPORATIONS ACT 2001 - SECT 513B
Voluntary winding up
Where a company resolves by special resolution that it be wound up voluntarily, the winding up is taken to have begun or commenced:
(a) if, when the resolution was passed, a winding up of the company was already in progress—when the last-mentioned winding up is taken because of this Division to have begun or commenced; or
(b) if, immediately before the resolution was passed, the company was under administration—on the section 513C day in relation to the administration; or
(c) if, immediately before the resolution was passed, a deed of company arrangement had been executed by the company but had not yet terminated—on the section 513C day in relation to the administration that ended when the deed was executed; or
(d) if the resolution is taken to have been passed because, at a meeting convened under section 445F, the company's creditors:

(i) passed a resolution terminating a deed of company arrangement executed by the company; and
(ii) also resolved under section 445E that the company be wound up;

on the section 513C day in relation to the administration that ended when the deed was executed;
(e) otherwise—on the day on which the resolution was passed.

3. For a liquidation that followed a voluntary administration - it is the day on which the administrators were first appointed to the company, even if a deed of company arrangement was in effect in the intervening period.

For those liquidations that commenced as a voluntary administration:

CORPORATIONS ACT 2001 - SECT 513C
Section 513C day in relation to an administration under Part 5.3A
The section 513C day in relation to the administration of a company is:
(a) if, when the administration began, a winding up of the company was in progress—the day on which the winding up is taken because of this Division to have begun; or
(b) otherwise—the day on which the administration began.

Transactions that do not fall within the specified time period, even by one day, cannot be caught by this section.

The relation back day is defined as:

Definition - Section 9 - Corporations Act
relation-back day, in relation to a winding up of a company or Part 5.7 body, means:
(a) if, because of Division 1A of Part 5.6, the winding up is taken to have begun on the day when an order that the company or body be wound up was made-the day on which the application for the order was filed; or
(b) otherwise-the day on which the winding up is taken because of Division 1A of Part 5.6 to have begun.

Insolvency of company

There is no requirement that the company was insolvent at the date of the transaction or to become insolvent because of the transaction. This also means that the statutory defences available to other parties - the defence of good faith and no reasonable grounds to suspect insolvency - are not relevant. In fact they are specifically excluded.

Orders available to the liquidator

The Courts may make an order under section 588FF. Recovery applications will have to be limited to a relief available under these provisions, but these cover almost every practical option. The most common relief sought is the return of the monies received or assets transferred, or the value of those assets.

Recovery is limited to the excess of consideration (or value) provided by the company, or the unreasonable benefit of the transaction. The whole transaction is not voided, unless there was no reasonable part to it.

CORPORATIONS ACT - SECTION 588FF
Courts may make orders about voidable transactions
(4) If the transaction is a voidable transaction solely because it is an unreasonable director related transaction, the court may make orders under subsection (1) only for the purpose of recovering for the benefit of the creditors of the company the difference between:
(a) the total value of the benefits provided by the company under the transaction; and
(b) the value (if any) that it may be expected that a reasonable person in the company's circumstances would have provided having regard to the matters referred to in paragraph 588FDA(1)(c).

Timetable for claims

Claims must be made within 3 years after the relation back day. That is, an application 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.

CORPORATIONS ACT 2001 - SECT 588FF
Courts may make orders about voidable transactions
(3) An application under subsection (1) may only be made:
(a) during the period beginning on the relation back day and ending:

(i) 3 years after the relation back day; or
(ii) 12 months after the first appointment of a liquidator in relation to the winding up of the company; whichever is the later; or

(b) within such longer period as the Court orders on an application under this paragraph made by the liquidator duringthe paragraph (a) period.

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: 10.5.2010