Victorian Court of Appeal broadens scope of “benefit” under section 588FDA

In Vasudevan v Becon Contructions (Australia) Pty Ltd [2014] VSCA 14, the Victorian Court of Appeal recently delivered a decision which has broadened the scope of an unreasonable director-related transaction under section 588FDA of the Corporations Act 2001 (Cth)(Act). Senior Associate, Elisabeth Pickthall and Associate, Stefano Calabretta discuss the case.

The facts

Warren Thompson was the sole director and shareholder of Wulguru Pty. Limited (Wulguru) and two other companies, Richmond Commercial Pty. Limited (Richmond) and Mulgrave Commercial Pty. Limited (Mulgrave).

On 23 February 2011, Mr. Thompson, Richmond, Becon and Wulguru entered into a deed to restructure certain debts owing by Richmond and Mulgrave to Becon Constructions (Australia) Pty. Limited (Becon). Pursuant to the deed, Wulguru (which was not in any way indebted to Becon prior to the deed) assumed liability to pay Mulgrave’s debt to Becon.

As security for its obligations under the deed, Wulguru executed a mortgage over its real property in favour of Becon. The deed provided that upon execution of the mortgage, Becon would discontinue legal proceedings that had been commenced against Mr Thompson (who was previously the guarantor for the debts) and forever discharge him from various liabilities. A winding up order in respect of Wulguru was made on 21 March 2012 and Liquidators were appointed. Before their appointment, Wulguru had entered into a contract of sale to sell some of its mortgaged property. Becon and another secured creditor (Owenlaw Mortgage Managers Ltd) each made a claim to the proceeds of sale of the property as secured creditors.

While the proceeds of sale of the property were being held in an interest- bearing escrow account, the Liquidators commenced proceedings in the Supreme Court of Victoria seeking orders that the deed and the mortgage in favour Becon were voidable as unreasonable director-related transactions under section 588DFA of the Act. The Supreme Court of Victoria disagreed with the Liquidators, giving rise to the present appeal.

The law

In summary, Part 5.7B of the Act provides that a transaction of a company is an unreasonable director-related transaction (and thus voidable) if:

• It is a payment, disposition or an issue of a security by the company entered into during the four years ending on the “relation back day”, in this case the date of the winding-up order.
• The payment, disposition or issue of security is made to a company’s director, to a close associate or a to person “on behalf of, or for the benefit of” a company’s director.
• A reasonable person in the position of the company would not have made the payment, disposition or issue, having regard to the benefits and detriments to the company.

The issue on appeal

It was not disputed by the parties that the mortgage was a disposition of property by Wulguru or that the deed resulted in Wulguru incurring an obligation to make such a disposition within the meaning of 588FDA(1) of the Act.

The main question on appeal was whether the deed and the mortgage engaged the operation of section 588FDA(1)(b)(iii) of the Act because the mortgage was made to a person “on behalf of, or for the benefit of” Mr Thompson.

The Liquidators’ argument

The main argument advanced by the Liquidators was that even though the mortgage was granted to Becon, Mr Thompson obtained a benefit by reason of Becon’s covenant not to sue him, which thus engaged the relevant section of the Act.

Becon’s argument

Becon’s principal argument (which found favour with the Associate Judge in the Court below) was that even if Mr Thompson might have obtained some indirect benefit from the deed and the mortgage because of Becon’s  covenant not to sue him, Mr Thompson did not directly benefit from the transaction – only Becon took a direct benefit because the mortgage was granted in its favour.

In addition, Becon also argued that even if Mr Thompson obtained a benefit, the benefit would need to give rise to an equitable interest, rather than a mere financial interest or a contractual right that Becon would not sue. This had been the traditional conception of “benefit” identified by Brereton J in the case of Re Great Wall Resources Pty Ltd (in liq) [2013] NSWSC 354.

The decision of the Court

The Court of Appeal (comprised of Justices Nettle, Beach and McMillan) ultimately found that there had been an unreasonable director-related transaction and ordered that the deed and the mortgage be declared void ab initio. As a result, the proceeds of sale held in escrow could be released to the Liquidators, and Becon did not have a claim to those funds. The Court of Appeal found that Mr Thomson did in fact receive a direct benefit because of Becon’s covenant not to sue him. The Court of Appeal placed particular emphasis on the notion that section 588FDA is an anti-avoidance provision aimed at preventing errant directors from stripping benefits out of companies to their advantage and noted that “it is to be presumed, therefore, that Parliament deployed the language of the section with the intention of achieving that objective” (per Justice Nettle at [19]). The words “for the benefit of” are to be given their natural and ordinary meaning and “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” (per Justice Nettle at [24]).

Regarding the unreasonableness of the transaction, at [32] and [33] the Court of Appeal effectively noted that a reasonable person in Wulguru’s circumstances would not have entered into the transaction in circumstances where it granted a mortgage over a previously unencumbered asset without any corresponding or other direct or indirect advantage.

Conclusion

The decision has important ramifications for liquidators and also the commercial community at large.

For liquidators, the decision now allows them to consider a wider range of transactions that previously might not have been considered unreasonable director related transactions. For financiers and other parties entering into contracts or taking security over property of companies, the decision serves as a reminder that consideration should be given to whether a director of a company obtains a benefit from the transaction. If he or she does, the transaction (and any associated contracts or issue of securities) may be declared to be void if the company is subsequently wound up and a Court finds that the transaction was also unreasonable.