Liquidators can negate unreasonable transactions by company directors
When companies face imminent financial collapse, directors, for all sorts of reasons and with a variety of motivations, can undertake transactions, but if these are considered “unreasonable” under the Corporations Act 2001, a liquidator can negate them.
Indeed, a liquidator can set aside such transactions and claw back proceeds up to four years before the day the winding up of a company is deemed to have begun.
And unlike many of the voidable transaction provisions of the Act, a liquidator doesn’t have to prove that a director’s unreasonable transaction was undertaken when the company was insolvent.
Furthermore, statutory defences that directors acted in “good faith” or had “no reasonable grounds to suspect insolvency” are not available to them for transactions deemed to be unreasonable.
What the law says is unreasonable
Section 588FDA of the Corporations Act says an unreasonable transaction can occur as a payment, as a transfer or other disposition of company property, as the issue of securities by a company, or in incurring an obligation by a company.
A transaction is unreasonable when the payment or disposition of company property is made to a company director, a close associate of a director of the company, or to a person on behalf of, or for the benefit of a director or close associate of a director.
The law further expects that a reasonable person would be aware of the extent of a company’s financial difficulty and would therefore, as a director, not be party to a transaction that in those circumstances would see company benefits transferred to other parties.
The Act defines a director as a person who is either appointed to the position of director or “acts in the position of a director”.
The definition includes so-called shadow directors who may not have been validly appointed as directors but act as directors.
In law, a close associate of a director can be a relative (spouse, parent, child, sibling or a more remote lineal ancestor), or a relative of a director’s spouse.
The “reasonable person” test
Although it is necessarily a subjective test, a Court can nonetheless test the reasonableness of a transaction involving a company director, given the legal expectation that as a reasonable person the director would be aware of the company’s circumstances, and accordingly would be aware of how the transaction could either benefit or adversely affect the company.
The Court will look at evidence of a company’s financial position at the time of an alleged unreasonable transaction, at its likely effects on reduction of company assets or increase of liabilities, and at the resulting extent of company benefit or detriment.
The Act enables a liquidator to seek to recover the difference between value given by a company in respect of a transaction, and the value received, if any. If, for example, a company sells one of its assets to a director for $50,000 when its actual value is $500,000 then the liquidator may seek to recover $450,000 from that director.
This is the procedure
The liquidator, unable to claim back this money by negotiation, might have to take the matter to Court.
In that event an order would be sought under Section 588FF of the Act requiring the director or close associate to pay to the company some or all the money lost by the company as a consequence of the unreasonable transaction.
A Court could also rule that property involved in an unreasonable transaction be transferred back to a company, or an amount be paid that, in the Court’s opinion, fairly represents some or all of the benefits to a person who was party to the transaction.
Company directors should be aware that liquidators will look closely at any transactions undertaken involving them or close associates of their companies.