Australia: Painting the directors red - unreasonable director-related transactions

This week's TGIF considers a decision in which the court examined whether payments made by a company to a creditor of the directors constituted unreasonable director-related transactions.

What happened?

From its incorporation in 1998, Action Paintball Games Pty Limited (Action Paintball) ran a paintball business from a property it leased in Rouse Hill.

Sometime in 2004, a decision was made by the directors of Action Paintball (the defendants) to seek an alternative premises from which to run the business and, in August 2005, they entered into a put and call option to purchase a property in Canoelands (the Property).

Following entry into the option, Action Paintball was unable to secure finance to complete the purchase of the Property. As a result, the defendants decided to purchase the Property in their own names with the intention of making it available to Action Paintball to conduct its business.

To finance the purchase of the Property, the defendants entered into two loan contracts with Perpetual Limited (Perpetual), one being secured by a mortgage over two of the directors' family home, the other, a mortgage registered on the title of the Property.

On 22 March 2006, the defendants completed the purchase of the Property. From the time of the purchase, Action Paintball made regular payments to Perpetual to discharge the defendants' obligations under the two loan contracts.

On 25 May 2012, a liquidator (the first plaintiff) was appointed to Action Paintball. The liquidator sought to recover 336 payments, totalling $501,497.68, made by Action Paintball to discharge the directors' debts to Perpetual as unreasonable director-related transactions under s 588FDA of the Corporations Act 2001 (Cth).

The directors denied that the payments were unreasonable director related transactions and argued that, if they were, the Court should exercise its discretion to deny the liquidator the relief sought.

Issues for determination

Accepting that the transactions should be considered by reference to the circumstances that existed at the time of each of the payments, the court set out two issues for determination:

  1. whether a reasonable person in Action Paintball's circumstances would not have made each of the disputed payments; and
  2. if so, what orders should be made under s 588FF.

The Decision

The Court found that some – but not all – of those payments made by Action Paintball to Perpetual constituted unreasonable director-related transactions.

In considering whether the payments made by Action Paintball constituted unreasonable director-related transactions, the Court affirmed the existing principles relating s 588FDA. The focus of the section is not the directors' conduct but the reasonableness of the company's conduct, objectively assessed, in entering into the transaction.

The test in 588FDA is to be applied to the relevant transaction taking into account all the circumstances as they existed when the transaction was entered into.

In considering the circumstances in this case, the Court weighed up the benefits and detriments to Action Paintball against the benefits to the directors and Perpetual as a result of the transactions.

The Court was not satisfied that a reasonable person in Action Paintball's circumstances would not have made any of the payments between 2008 and 2011. The payments were plainly made pursuant to an arrangement by which the directors took on obligations primarily to secure the Property for the long-term benefit of Action Paintball.

However, the financial position of Action Paintball changed materially in the financial year ended 30 June 2011 when it became liable to make a significant payment to the ATO for superannuation guarantee charges. As such, the Court found that in light of these significant tax liabilities, a reasonable person in the company's circumstances would have ceased to make the payments between January 2011 and 25 May 2012.

What relief was granted?

Despite the defendants plea that no relief should be granted against them, the Court held that, notwithstanding the use of the word "may" in s588FF(1), it did not retain a discretion to refuse to grant relief.

In the circumstances, the relief to be granted was the difference between the total value of the benefits provided by the company under the transaction, and the value (if any) that it may be expected that a reasonable person in the company's circumstances would have provided having regard to the matters referred to in s 588FDA(1)(c).

On this basis, the Court ordered that the total amount of the payments found to be unreasonable director-related transactions should be repaid as there was no value to Action Paintball making the payments from 2011 given its perilous financial position.

Comment

Liquidators seeking to bring claims pursuant to s 588FDA should be mindful of the broad considerations adopted by the Court when examining the circumstances surrounding the transaction(s) entered into by the company.

Consideration should be given not only to the benefits sustained by the directors as a result of the transaction, but also the net effect of the transaction. This involves an examination of the benefits and detriments to the company and any third parties.

The catch-all, "any other relevant matter" provision contained in s 588FDA remains broad and allows an opportunity for liquidators – and defendants for that matter – to raise any issue with the court he/she deems relevant to the reasonableness of the company's actions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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