Unreasonable director-related transactions

A transaction that has little or no benefit to the company that is made by a director or close associate of the company is called an ‘unreasonable director-related transaction’.

What is an unreasonable director-related transaction?
A transaction that has little or no benefit to the company that is made by a director or close associate (as defined by the Corporations Act 2001) of the company is called an ‘unreasonable director-related transaction’. Under the Corporations Act, the other party to the transaction is required to return the asset or make a payment to the liquidator.

Who recovers an unreasonable director-related transaction?
Only liquidators may recover unreasonable director-related transactions. Unreasonable director-related transactions cannot be recovered by provisional liquidators, voluntary administrators, deed administrators or controllers.

What is the basis of the claim?
The liquidator must prove that:

  1. a transaction was entered into
  2. a director or close associate of the director was involved in the transaction
  3. either there was no benefit to, or there was a detriment to the company.

Why recover an unreasonable director-related transaction?
A liquidator will examine whether the company entered into any transactions that reduced the amount of assets available for distribution in the liquidation.

A liquidator will seek recovery of money or assets transferred to make a more equitable distribution to creditors.

How much can be recovered from an unreasonable director-related transaction?
The liquidator will recover the difference between the value that was given by the company and the value received by the company. Only the excess between the two values is recoverable.

What are the main elements of unreasonable director-related transactions?
There are two main elements to an unreasonable director-related transaction: the transaction and the party involved.

  1. The transaction
    The transaction must involve the company. The transaction can be a payment; a transfer or disposition of property; a security, or incurring an obligation or commitment to make a payment, disposition or issue. Section 588FDA is designed to cover money or assets actually leaving the company, or commitments (like security interests) being made over money or assets.
  2. A director or close associate must have been involved
    The transaction must involve one of the following:
  1. a director of the company
  2. a close associate of a director of the company
  3. a ‘nominee’ acting on behalf of, or for the benefit of, a director or their close associate.

Nominees are people who are trying to disguise their involvement by including another person to the transaction, but where the related party still receives the benefit.

Who is a director?
A director is defined under section 9 of the Corporations Act as:

(a) a person who:

(i)   is appointed to the position of a director; or

(ii) is appointed to the position of an alternate director and is acting in that capacity; regardless of the name that is given to their position; and

(b) unless the contrary intention appears, a person who is not validly appointed as a director if:

(i) they act in the position of a director; or

(ii) the directors of the company or body are accustomed to act in accordance with the person’s instructions or wishes.

Who is a close associate?
A close associate is:

  • a relative or de facto spouse of a director, or
  • a relative of a spouse or of a de facto spouse, of the director. A relative is a spouse, parent or remoter lineal ancestor, son, daughter or remoter issue, or brother or sister of the person.

How is a transaction considered to be unreasonable?
The company must benefit from the transaction for it to be considered ‘reasonable’. Therefore, if the benefits of the transaction are outweighed by the detriment of the transaction to the company, it is deemed unreasonable. The liquidator will look for a reduction in the net position of company assets caused by the transaction to determine whether it is reasonable or not.

What is a reasonable person test?
The court will look at the transaction from the view of a ‘reasonable person’ in the company’s circumstances. This is someone that has knowledge of the company’s financial position, who is not trying to gain a personal benefit, or give a benefit to anyone else, or cause a loss to the company. It is assumed that a reasonable person would not enter into a company transaction that would cause detriment to the company or reduce its assets.

What time period is involved?
The transaction must have been entered into within four years before the ‘relation-back day’, or between the relation-back day and the appointment date. The relation-back day is the day that the liquidation legally commences. There are three possible dates for the relation-back day in corporate administrations:

  1. For a liquidation following a voluntary administration, the relation-back day is when the administrators were first appointed to the company, even if a Deed of Company Arrangement (DOCA) was in effect in the intervening period.
  2. For a court appointment, the relation-back day is the day the application was filed.
  3. For a creditor’s voluntary winding up, the relation-back day is the date of the members’ meeting that resolved to wind up the company.

Does the company need to be insolvent?
No. The company does not need to have been insolvent at the time of the transaction or because of the transaction. This means the statutory defences available in other recovery actions—such as the good faith defence and no reasonable grounds to suspect insolvency do not apply.

What relief is available to the liquidator?
Recovery applications are limited to a relief available under section 588FF of the Corporations Act. The most common relief sought by liquidators is the return of the monies or assets received by the other party. However, recovery is limited to the excess or the unreasonable benefit of the transaction. The whole transaction is not voided, unless there was no ‘reasonable’ part to it. Therefore a recovery is generally the payment of money.

How long does the liquidator have to make a claim?
A claim application for an unreasonable director-related transaction must be made within three years after the relation-back day. It is insufficient for the liquidator to only have issued a demand within that period, legal proceedings must be commenced within the three years.

The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 3.11.2017