The recent case of Woodgate v Fawcett [2008] NSWSC 868 considered the provisions regarding unreasonable director-related transactions. A feature of s588FDA Corporations Act 2001 is that the company need not have been insolvent at the time or as a result of the unreasonable transaction. This broadens the range of potential transactions which may be attacked by a liquidator.
Section 588FDA was introduced after community outrage at One.Tel directors who had paid themselves $14 million in bonuses the year prior to the collapse.
Definition
A transaction is an unreasonable director-related transaction if:
- it is a transaction made in favour of (or on behalf of or for the benefit of) a director or close associate of a director; and
- a reasonable person in the company's circumstances would not have entered into the transaction having regard to factors including:
- the benefits (if any) to the company;
- the detriment to the company; and
- the benefits to the other parties.
'Transactions' is defined broadly to include the payment of funds, conveyance or disposition of company property, issue of securities (including options), or the incurring of an obligation to make such a payment, disposition or issue.
A 'close associate' means a relative or de facto spouse of a director, or a relative of a spouse or de facto spouse of a director. The reasonableness is assessed by considering the circumstances as they exist at the time when the transaction is entered into, rather than when the obligation was incurred (section 588FDA(2)).
An unreasonable director-related transaction is voidable under s588FE(6A) if it was entered into within 4 years of the relevant commencement date for the liquidation process.
As with other voidable transactions, a court has wide powers to make orders including orders for the return of property transferred or the repayment of the difference between the total value of the benefits less the value that a reasonable person in the company's circumstances would have provided (often, this is the whole amount of the benefit).
Examples of unreasonable director-related transactions
Payment to a third party
In Woodgate, the defendants borrowed $2.5 million from a lender, and loaned the amount to their son's company without obtaining security. Days prior to the appointment of an administrator, the son sold properties owned by the company and discharged his parents' loan by direct payment to the lender.
The Supreme Court of NSW held that it was an unfair preference and an unreasonable director-related transaction, and ordered the parents to pay $2.5 million to the company. The court commented that the son was "the steward of a transaction which had the effect of discharging his parents' obligations leaving unsecured creditors without any prospect of payment."
The court undertook the benefits and detriments analysis required under s588FDA(1)(c):
- the benefit to the company - it was able to discharge its debt to the parents;
- the detriment to the company - it was left in a position where it was unable to satisfy its other non-secured creditors; and
- the benefit to the parents - they received payment of their unsecured obligation in full in preference to the claims of other unsecured creditors.
Granting of a mortgage to secure past debts
In Ziade Investments Pty Ltd (In Liq) v Welcome Homes Real Estate Pty Limited [2006] NSWSC 457, the company granted mortgages to secure past loans made by a director's parents and their companies. The mortgages did not secure future advances. Gzell J concluded that there was no benefit to the company in granting the mortgages as they did not secure future advances, and the company was unable to raise further funds as a result of the mortgages. The benefit to the parents was that they "obtained the advantage of security they had not held before". Accordingly, the granting of mortgages to the parents were unreasonable director-related transactions.
The companies owned by the parents were not considered 'close associates' as His Honour held that the definition did not include derivative benefits in the form of increased value of the parents' shareholdings.
On appeal, the Court of Appeal agreed with Gzell J's approached and dismissed the appeal. The Court of Appeal also commented that "what is normal commercial practice, while not decisive, is relevant to the question" of whether it was an uncommercial transaction or unreasonable director-related transaction. The issue of whether the companies owned by the parents were 'close associates' was not considered on appeal.
Direction to pay
In Universal Financial Group v Mortgage Elimination Services [2006] NSWSC 1132, the director of a company had directed two mortgage facilitators to pay trailer commissions due to the company to another company owned by his son. It was argued that the directions were not 'transactions'. The Supreme Court of NSW said that 'transaction' should be read having regard to the policy underlying the voidable transaction provisions, and captures:
"any arrangement between two or more parties which produces legal consequences ... a direction which causes payments to be made to B which otherwise would be made to A is a transaction, least when acted upon".
The court found that the directions 'lacked any proper commercial justification' and benefited the son's company which had no claim to the commissions. The court found that a reasonable person in the company's circumstances would not have given the directions. This case did not consider Ziade.
Reduction of contract price
In SNS Developments (Qld) Pty Ltd (In Liq) v Hayde [2008] QDC 2, the Court awarded summary judgment in favour of the liquidator where the company had reduced the contract price for a conveyance of property from the company to the defendant by $20,000 for his past services as a director of the company.
Conclusion
Given that the Court will scrutinise transactions involving relatives much more closely than arms length transactions (McDonald v Hanselmann (1998) 28 ACSR 49), and the broad range of transactions which may be captured by this provision, it is important for a director to seek advice when contemplating such transactions even if the company is not insolvent, and is privately owned. A potential recipient of such benefits should also seek advice prior to entering into the transaction as the recipient may have to repay the funds years down the track.
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.
