A wider scope for liquidators to attack unreasonable director-related transactions

Approximately 11 years ago, largely as a result of public resentment of bonuses being paid to directors of insolvent companies, the Corporations Act was amended by the Corporations Amendment (Re-Payment of Director’s Bonuses) Act 2003.  The amendment made it possible for liquidators to not only seek to recover director bonuses but to also recover any “unreasonable director-related transactions” pursuant to the newly added section 588FDA of the Corporations Act.

Legislation

Unreasonable director-related transactions involve payments (or other dispositions of property) made by a company to a director, a “close associate” of a director or to a person on behalf of, or for the benefit of, a director or close associate.

A transaction is unreasonable if 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;

ii)   the detriment to the company of entering into the transactions;

iii)   the respective benefits to other parties to the transaction of entering into it; and

iv)   any other relevant matters.

Section 588FDA claims have advantages over more traditional claims such as uncommercial transactions and unfair preferences because the liquidator is not required to prove insolvency in order to succeed with a claim. As a result, liquidators have increasingly utilised the unreasonable director-related transaction provisions in recent years.

Early decisions

A number of first instance decisions have tended to narrow the scope of section 588FDA.  In particular, the courts have held that a claim by a liquidator could only succeed if there was a “direct benefit” to the director or close associate.  For example it has been held that a director who is a shareholder of another company that received a benefit did not fall with the scope of section 588FDA.

In Re Great Wall Resources Pty Ltd (in liq) [2013] NSWSC 354 the Supreme Court of New South Wales held;

“only a direct benefit will suffice and a benefit to a company of which the director is a shareholder, even the sole shareholder, will not”.

Recent Case

In a recent case in the Supreme Court of Victoria, the issue of “direct benefit” was considered in detail.  In this case the company entered into a deed assuming liability for a debt owed by its director to a third party, and the company also granted a mortgage to secure the debt.  At first instance the Supreme Court of Victoria followed the earlier line of authority and found that the transaction was not directly “on behalf of, or for the benefit of” the director and therefore the liquidator was unsuccessful.

On appeal, in the first consideration of unreasonable director-related transactions at an appellate level, the Victorian Court of Appeal found that there was in fact a direct benefit to the director and overturned the decision; Vasudevan (as Joint and Several Liquidator of Wulguru Retail Investment Pty Ltd) (In Liq) & ors v Becon Constructions (Australia) Pty Ltd & Anor [2014] VSCA14.   

The Court then went further and rejected the earlier line of authority that the concept of benefit was limited to a direct benefit.  It held that the natural and ordinary meaning of “for the benefit of” a person is that it be “for the advantage, profit or good” of the person which “accords to the objective of the section of preventing directors stripping benefits out of companies to their own advantage”.

Nettle JA went on to say;

“…. given the ease with which an errant director might channel benefits from a company under his charge to another company in which he is financially although not legally or equitably interested, there is every reason to suppose that Parliament intended not to confine the meaning of the expression to something in the nature of an equitable interest”.

Conclusion

This recent decision suggests that the courts will now adopt a broader interpretation when considering whether a transaction was “for the benefit of” a director.  Liquidators will now look closely at benefits received by directors whether direct or indirect, including transactions made with other entities in which the director has an indirect financial interest. 

Directors should be aware that a transaction which benefits another company in which the director is a shareholder may now be attacked by a liquidator if the director has obtained any form of indirect benefit as a result of the transaction.

Author: Mark Tierney