The Victorian Court of Appeal recently held that a payment, disposition or grant of security by a company to a person on behalf of, or for the benefit of a director of the company, extends to a mortgage of land given by the company to a creditor of the director in consideration of a covenant by the creditor not to sue the director. 

As a result, insolvency practitioners now have stronger judicial guidance as to what constitutes a 'benefit' for the purposes of setting aside or varying voidable transactions, which should assist in recovering proceeds for unsecured creditors.

The decision has expanded the types of transactions that can be set aside, and insolvency practitioners should be alert to circumstances in which there may be a potential right to set aside or vary unreasonable director related transactions.

The facts

Mr Thompson was the sole director and shareholder of Wulguru Pty Ltd (Wulguru), Richmond Commercial Pty Ltd (Richmond) and Mulgrave Commercial Pty Ltd (Mulgrave).

As Mr Thompson had personally guaranteed the obligations of Mulgrave and Richmond, when those companies defaulted in performance of their obligations, Becon Constructions (Australia) Pty Ltd (Becon) instituted proceedings against Mr Thompson to recover the amounts due.

In February 2011, Mr Thompson, Wulguru, Richmond and Becon entered into a deed to restructure debts owed to Becon by Richmond and Mulgrave (Deed), pursuant to which:

  • Wulguru assumed a joint and several liability to pay Mulgrave's debt to Becon of some $939,000 and interest on that debt;
  • Wulguru executed a mortgage over real property in favour of Becon as security for the performance of Wulguru's obligations under the Deed (Mortgage); and
  • upon execution of the Mortgage, Becon agreed to discontinue the proceedings against Mr Thompson and release him from various liabilities to Becon.

In March 2012, Wulguru was wound up in insolvency. Before then, Wulguru entered into a contract of sale to sell some of the mortgaged property. Wulguru's liquidators sought Becon's agreement to relinquish its claim to the sale proceeds on the grounds that the Deed and Mortgage constituted unreasonable director-related transactions and were voidable. Becon refused. 

The decision at first instance

The Court at first instance dismissed the Liquidators' application to set aside the Deed and the Mortgage as unreasonable director related transactions under section 588FDA of the Corporations Act 2001 (Act). 

Prior to the Court of Appeal's decision, the accepted position (which was followed by the Court at first instance), was that for the purposes of unreasonable director-related transactions under section 588FDA of the Act, a 'benefit' was one that involved the director receiving an equitable interest or an equity in the property the subject of the transaction, and excluded financial and/or contractual rights or benefits. 

The Court of Appeal's decision

The questions before the Court of Appeal were whether the execution of the Deed and the Mortgage were made:

  • on behalf of Mr Thompson because the Mortgage was executed on his instructions; or
  • for Mr Thompson's benefit because it had the effect of relieving him of his contractual obligations to Becon as guarantor.

The Court of Appeal overturned the decision at first instance.  In doing so, His Honour Justice Nettle held that:

  • while the Deed and the Mortgage were executed on the instructions of Mr Thompson, in the context of section 588FDA of the Act, this was not in itself sufficient for it to be held to have been executed on behalf of Mr Thompson; and
  • the execution of the Deed and the Mortgage was for Mr Thompson's direct benefit, as Becon agreed to release Mr Thompson from his liability as guarantor, with the effect that the transaction fell within the ambit of section 588FDA of the Act.

Justice Nettle noted that despite the natural and ordinary meaning of the phrase 'for the benefit of' in section 588FDA of the Act, the provision is designed to catch a benefit flowing to a close associate of the company in liquidation, whether or not the benefit has the effect of legally or financially advantaging the director in question. His Honour made plain that the objective of section 588FDA was to stop directors stripping benefits out of companies to their own advantage.

The Court of Appeal held that the Deed and the Mortgage were unreasonable director-related transactions within the meaning of section 588FDA of the Act, and were voidable pursuant to section 588FE(2A) of the Act. That finding was made in circumstances where the 'benefit' derived by Mr Thompson under the Deed was merely contractual in nature.