When a company goes into liquidation liquidators will often try to ‘claw back’ uncommercial transactions. The recent case of 640 Elizabeth Street Pty Ltd (in liq) & Ors v Maxcon Pty Ltd [2015] VSC 22 considered whether securing the indebtedness of a third party to avoid potential litigation exposure is an uncommercial transaction. 

Background facts

640 Elizabeth Street Pty Ltd (640) purchased a property and entered into a joint venture deed (JVD) with Jabbour 640 Pty Ltd (Jabbour) to develop it. Elan Apartments Pty Ltd (Elan), a special purpose vehicle, was appointed as the development manager.

Elan entered into a building contract with Maxcon Pty Ltd (Maxcon) for the construction of 54 residential apartments on the property (the Development). When it came time to pay Maxcon, they were told the retention money required to be set aside and held under the building contract had been used to discharge a mortgage to Westpac.

A director of 640 and Elan executed for and on behalf of 640 and Elan a Deed of Acknowledgment (Deed) pursuant to which 640 charged all its land with payment of amounts due by Elan to Maxcon.  Maxcon lodged a caveat on title to various apartments claiming an interest pursuant to the Deed. Maxcon’s solicitors also excecuted a mortgage over the said titles, but this was never registered.  The Deed, mortgage and forbearance to sue were all treated by the Court part of one transaction (the Transaction).

640 later went into liquidation, and two liquidators were appointed. The liquidators commenced an application claiming the Transaction was an uncommercial transaction under s 588FB of the Corporations Act 2001 (Cth). Following this, the caveat was removed. The last unit in the Development was sold and a portion of the net proceeds was paid into a trust account in the names of the solicitors for the parties, on account of Maxcon’s claim under the mortgage.

Initial decision

At trial, the liquidators claimed that the Transaction was an uncommercial transaction. They submitted that by entering into the Deed and mortgage, 640 suffered detriment in the nature of a liability to pay Elan’s debt and further encumbered its property with payment of those amounts, without any corresponding benefit. The Trial Judge found that this was not an uncommercial transaction, for reasons including:

  • If the Transaction has not been entered into, Elan would have incurred significant legal fees in defending the subsequent litigation. The forbearance and avoidance of those legal costs, which would have been paid out of the Joint Venture Account, increased the net profit of, and was thus a benefit to, 640;
  • If the Transaction had not occurred, it is likely Elan would have had to use the gross sales receipts from the sale of the units in payment of its debt to Maxcon. Therefore there was no detriment of any real substance to 640; and
  • The Transaction was the sort of transaction that a reasonable businessman would enter into in the circumstances.

Appeal decision

The liquidators appealed the Trial Judge’s decision on a number of grounds:

  1. The Transaction did not benefit 640 as there was no evidence to support any findings that Elan denied the claim or would have defended the claim and that any costs would have been incurred

 The Appeal Judge found that 640 did receive a benefit. Unless it entered into the Transaction it was exposed. By avoiding exposure to a direct or derivative claim or any exposure or risk to the diminution amount it would receive it had undoubtedly benefited. Commercially speaking, any benefit to Elan was a benefit to 640. The Appeal Judge found that a reasonable person would regard the Transaction as having some commercial benefit to 640.

  1. The transaction was detrimental to 640 as it prejudiced the unsecured creditors of 640

It was held that the Transaction was not, in all of the circumstances, detrimental to 640. The consequences of the Transaction and the position had the Transaction not been entered into would, given the various provisions of the JVD, have had substantially the same effect on 640. Its net position would have been the same so it was no worse off. The amount required to be paid because of the Transaction would have been reflected in a greater return from Elan, as Elan would have been relieved of the obligation to pay. In regards to the argument regarding unsecured creditors, the Appeal Judge found that despite retaining part beneficial ownership in the Joint Venture Account, the funds never get back to 640 as an asset free of any burden or encumbrance and therefore available to its unsecured creditors. Thus the Transaction did not cause any detriment to 640.

  1. Any benefit to other parties required consideration and assessment as to whether such benefit was proportional to the detriment to 640

Elan was in breach of the building contract and Maxcon wished to be restored as nearly as possible to the position that it should have been in. The Appeal Judge agreed with the Trial Judge that in a practical sense providing substitute security in such circumstances was the very kind of thing that a reasonable businessman would do in that situation. The Appeal Judge affirmed that in the circumstances the benefit to Maxcon was not that great, nor was it so extravagant or out of proportion so as to render it uncommercial.

  1. The Transaction was not commercially sensible from 640’s point of view, nor was it explicable by ordinary commercial practice

The Appeal Judge relied on the same reasoning as under the third ground, as a reasonable person in the company’s circumstances would have entered into the Transaction and it was not of such a magnitude that it lacked a commercial quality or was not readily explainable by normal commercial practice.

The ultimate conclusion was the Transaction was not an uncommercial transaction.

TAKE-HOME TIPS

This decision indicates that a transaction involving a third party will not necessarily be uncommercial, and consequently voidable, where the company receives a benefit via avoiding a potential exposure and the company's net position remains the same. In such circumstances it is unlikely an uncommercial benefit to the third party or a detriment to the insolvent company will be considered to exist.