Voidable transactions When a company becomes insolvent, sections 588FA and 588FB of the Corporations Act 2001 (Cth) (Corporations Act) empower liquidators to investigate voidable transactions, including unfair preference and uncommercial transactions as well as unreasonable director-related transactions.
The following update focusses on some recent judicial developments in the law surrounding recovery of unreasonable director-related transactions. These developments may potentially broaden the scope of potential recoveries open to insolvency practitioners under section 588FDA of the Corporations Act.
Unreasonable director-related transactions
Under section 588FDA of the Corporations Act, a transaction is an unreasonable director-related transaction if:
- the transaction is a payment made by the company, a disposition by the company of property of the company, the issue of securities by the company, or the incurring of an obligation to make a payment, disposition or issue; and
- the payment is to be made to a director, a close associate of a director, or a person on behalf of or for the benefit of a director or close associate; and
- it may be expected that a reasonable person in the company's circumstances would not have entered into the transaction, having regard to specific matters.
Judicial interpretation of section 588FDA
Until recently, judicial authority suggested that for a payment to be made “for the benefit of” another person, the benefit must be a direct benefit. Any benefit that could be characterised as “indirect” falls outside the ambit of section 588FDA, and is thus irrecoverable under section 588FDA of the Corporations Act. So, what precisely constitutes a direct benefit?
In Ziade Investments Pty Ltd (Ziade Investments) vWelcome Homes Real Estate Pty Ltd  NSWSC 457, Ziade Investments granted mortgages over two of its properties in order to secure past loans that were made to various companies. Mr Ziade was a director of Ziade Investments, and he and his wife were the shareholders of the companies that received the mortgages. Ziade Investments was subsequently wound up in insolvency, and the liquidator sought orders that the mortgages were unenforceable, and that he be paid monies received when the mortgages were discharged.
Gzell J held that the mortgages were uncommercial transactions, and were therefore voidable transactions. It was unnecessary for his Honour to decide whether the creation of the interests in the mortgages were unreasonable director-related transactions, as it was not disputed that Ziade Investments did not receive any benefit from the mortgages. However, his Honour expressed the view that despite the fact that Mr and Mrs Ziade were the shareholders of the companies that received the mortgages, they did not receive a direct benefit from receiving the mortgages.
His Honour explained that the various companies, as separate legal entities, received the benefit of the mortgages in their own right, and not for the benefit of their shareholders. He said that, in his view, section 588FDA of the Corporations Act was not intended to apply to indirect benefits constituted by value increases in shares of a company or a trust that benefited from the transaction.
The reasoning in Ziade Investments v Welcome Holmes has been applied by a number of subsequent cases, including Re Lawrence Waterhouse Pty Ltd (in liq), Shaw v Minsden Pty Ltd NSWSC 964, Re Great Wall Resources Pty Ltd (in liq) NSWSC 354 (Re Great Wall Resources), and Verge v Stenson  WASC 158 (Verge).
In Verge, a director of an insolvent company pledged the title deeds to a property owned by the company as security for a personal loan. The liquidators sought a declaration that the loan agreement was void, as it was an unreasonable director-related transaction.
The Supreme Court of Western Australia, held that, while the company did own the property, it was not a party to the loan and did not receive any benefit from the transaction. The transaction was for the direct benefit of the lender and, while there may have been an indirect benefit to the borrower, an indirect benefit was not sufficient to bring the transaction within the scope of section 588FDA of the Corporations Act.
Changes to the current law on unreasonable director-related transactions
A recent decision of the Victorian Supreme Court of Appeal inVasudevan (as Joint and Several Liquidator of Wulguru Retail Investments Pty Ltd) (in liq) v Becon Constructions (Australia) Pty Ltd  VSCA 14 (Vasudevan), has the potential to alter the existing line of authority in relation to whether a transaction that indirectly benefits a director or close associate of a company, falls within the scope of section 588FDA of the Corporations Act.
The facts of Vasudevan were as follows:
- Mr Thompson was the sole director and shareholder of Wulguru Pty Ltd (Wulguru), Richmond Commercial Pty Ltd (Richmond) and Mulgrave Commercial Pty Ltd (Mulgrave).
- Richmond and Mulgrave were in debt to a creditor, Becon Constructions (Australia) Pty Ltd (Becon). These debts were personally guaranteed by Mr Thompson.
- Wulguru and Becon defaulted on their debts, so Becon initiated proceedings against Mr Thompson.
- Mr Thompson, Wulguru, Richmond and Mulgrave entered into a deed to restructure the debts (Deed). Under the Deed, Wulguru assumed joint and several liability for the debts of Richmond and Mulgrave, in consideration for Becon discontinuing proceedings against Mr Thompson, and releasing and forever discharging him from various liabilities.
- In accordance with the Deed, Wulguru also executed a mortgage (Mortgage) over real property in favour of Becon, as security for the performance of Wulguru’s obligations under the Deed.
- Approximately 13 months after execution of the Deed, Wulguru was wound up in insolvency, and two liquidators were appointed.
The liquidators claimed that the Deed and Mortgage constituted unreasonable director-related transactions as they were entered into to benefit Mr Thompson, and were therefore voidable under section 588FDA of the Corporations Act.
At first instance, the Supreme Court of Victoria held that although Mr Thompson received a benefit by entering into the Deed, the transaction did not fall within the scope of section 588FDA of the Corporations Act. The Associate Judge interpreted section 588FDA as meaning that the payment must be “for the benefit” of the director, and not merely a benefit that was derived by the director from the transaction. His Honour found that the transaction did not fall within the scope of section 588FDA and dismissed the liquidators’ claims.
On appeal, the issue to be decided was whether or not the Deed and Mortgage fell within the scope of section 588FDA on the basis that they were either made “on behalf of” Mr Thompson because they were executed on his instructions, or “for the benefit of” Mr Thompson because they had the effect of relieving him of his obligations to Becon.
Nettle JA disagreed with the Associate Judge, stating that he doubted Parliament had intended to confine section 588FDA to only direct benefits, and section 588FDA should therefore not be construed as such. His Honour considered the authorities ofZiade Investments v Welcome Holmes and Re Great WallResources and stated that those cases stood as authority that section 588FDA is limited to direct benefits. However, his Honour pointed out that the underlying purpose of the section 588FDA is to prevent directors from stripping benefits out of companies for their own advantage. Therefore, section 588FDA should be construed inline with that objective.
Nettle JA stated that according to ordinary acceptation, “benefit” includes both direct and indirect benefits. Further, the natural and ordinary meaning of the phrase “for the benefit of” a person is “for the advantage, profit or good” of the person, and should not be confined to something in the nature of an equitable interest. His Honour stated that both these interpretations are in accordance with the underlying purpose of section 588FDA.
Nettle JA also addressed the “close associate” provisions, stating that the provisions are intended to catch a benefit received by a close associate, whether or not the benefit is legally or financially advantageous to the director in question. On the other hand, the natural and ordinary meaning of “for the benefit of” is intended to catch a legal or financial benefit that advantages the director in question, regardless of whether it is paid to the director or a close associate of the director.
Nettle JA (with whom Beach JA and McMillan AJA concurred) ultimately decided that, as Mr Thompson had received a direct benefit from the Deed and Mortgage in the form of Becon’s covenant not to sue, and the possibility of ultimate relief from his obligations, the transaction was an unreasonable director-related transaction and therefore void.
Impact of Vasudevan on liquidators and creditors
Nettle JA’s analysis of unreasonable director-related transactions in Vasudevan is yet to be considered and applied by the Courts. However, should it be applied, Vasudevan may have far reaching consequences for any third party that receives a legal or financial payment that advantages a director of a company.
Vasudevan significantly expands the operation of section 588FDA of the Corporations Act to not only those transactions that directly benefit a director or close associate of a company, but also to those transactions that indirectly benefit a director or close associate. This allows liquidators to attack significantly more transactions than would otherwise have been available to them, prior to this decision.
Liquidators will be able to rely on section 588FDA to attack any transaction where a director or a close associate of a director had a financial interest in the outcome of the transaction. Where the transaction is a unreasonable director-related transaction, the Corporations Act gives liquidators a four year relation back period, and does not require the liquidators to prove insolvency at the time of the transaction, or to establish that the company became insolvent as a result of the transaction. Further, the defences available to third parties in relation to unfair preference claims, or uncommercial transactions do not apply to unreasonable director-related transactions.
There still remains a limited defence available to third parties in relation to an otherwise voidable transaction. If a transaction is voidable solely because it is an unreasonable director-related transaction, the Court may make orders, pursuant to section 588FF(4) of the Corporations Act, recovering, for the benefit of creditors of the company, the difference between:
- the total value of benefits provided by the company under the transaction; and
- the value (if any) that a reasonable person in the company’s circumstances would have been provided, having regard to specific matters.
Financers and creditors now face an increased risk that liquidators will apply to void transactions that may be considered to be unreasonable director-related transactions, many years after the transactions actually occurred. As a result of Vasudevan innocent third parties now face the distinct possibility of unfair consequences in respect of these transactions.
Until further judicial guidance is provided in relation to what constitutes an unreasonable director-related transaction, this area of law remains relatively uncertain.