Unreasonable Director-Related Transactions and How to Defeat Them

Unreasonable director-related transactions occur when:

1. There is a transaction of a company; and
2. The transaction is a payment, conveyance, transfer, disposition of property, the issue of securities, and/or the incurring of an obligation; and
3. The transaction is, or is to be, made to a director of the company, a close associate of a director, or a person on behalf of, or for the benefit of, a director or close associate; and
4. It may be expected that a reasonable person in the company’s circumstances would not have entered into the transaction.

Unreasonable director-related transactions claims are one of the types of voidable transactions in company insolvency outlined at section 588FDA of the Corporations Act 2001 (CTH) (“the Corporations Act”).

There are a number of defences and exceptions to the above which may mean that a director does not have to repay hard-earned monies to the liquidator.

However, there is no requirement that the unreasonable director-related transaction occurred when the company was insolvent.  Unlike other voidable transactions, unreasonable director-related transactions do not require the transaction to be an insolvent transaction, and so the possible insolvency defence is not available to these types of claims.

In this article our insolvency lawyers explain in detail unreasonable director-related transactions claims under the voidable transaction regime and details the possible defences and exceptions to unreasonable director-related transactions claims.

If you have been contacted by a liquidator in relation to unreasonable director-related transactions claims, you should contact an insolvency lawyer as soon as possible to attempt to defend the liquidator’s demand for money

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What are Unreasonable Director-Related Transactions?

Unreasonable director-related transactions in company insolvency are transactions entered into by the company for the benefit of the director, or another person, which can be avoided and recovered by the liquidator of the company in liquidation.

Voidable transactions can include:

1. 588FA – Unfair preferences;
2. 588FB – Uncommercial transactions;
3. 588FC – Insolvent transactions;
4. 588FD – Unfair loans to a company; and
5. 588FDA – Unreasonable director-related transactions.

This article will focus on unreasonable director-related transactions.

Unreasonable Director-Related Transactions

Section 588FDA of the Corporations Act says:

(1)  A transaction of a company is an unreasonable director-related transaction of the company if, and only if:

(a)  the transaction is:

(i)  a payment made by the company; or

(ii)  a conveyance, transfer or other disposition by the company of property of the company; or

(iii)  the issue of securities by the company; or

(iv)  the incurring by the company of an obligation to make such a payment, disposition or issue; and

(b)  the payment, disposition or issue is, or is to be, made to:

(i)  a director of the company; or

(ii)  a close associate of a director of the company; or

(iii)  a person on behalf of, or for the benefit of, a person mentioned in subparagraph (i) or (ii); and

(c)  it may be expected that a reasonable person in the company’s circumstances would not have entered into the transaction, having regard to:

(i)  the benefits (if any) to the company of entering into the transaction; and

(ii)  the detriment to the company of entering into the transaction; and

(iii)  the respective benefits to other parties to the transaction of entering into it; and

(iv)  any other relevant matter.

This section asks a number of questions, namely:

1. What is a transaction by the company; and
2. What is a close associate of a director of the company; and
3. What does on behalf of, or for the benefit of mean; and
4. What have the Courts said about the objective test.

We will attempt to answer these questions below.

What is a Transaction by the Company?

Ordinarily, transactions are defined in section 9 of the Corporations Act.  However, section 588FDA seems to limit the scope for unreasonable director-related transactions and says that the transaction must be:

1. A payment made by the company; or
2. A conveyance, transfer or other disposition by the company of property of the company; or
3. The issue of securities by the company; or
4. The incurring by the company of an obligation to make such a payment, disposition or issue.

The Courts have decided that a transaction by the company can include (but in no way limited to):

1. A gift of money or property;
2. An assignment of debt;
3. Forgiving a debt or debts;
4. Granting a mortgage or charge;
5. Granting a security;
6. Issuing shares in the company;
7. Relinquishment of rights;
8. The granting of an encumbrance;
9. The payment of company money; and
10. The transfer of real or personal company property.

Because there is no definition of most of the transactions in the Corporations Act, the words can also be given their ordinary meaning in most cases.  Dictionary definitions are a good starting point.

The transaction (payment, disposition or issue) is, or is to be, made to a director of the company; or a close associate of a director of the company; or a person on behalf of, or for the benefit of, a director or a close associate of a director of the company.

What is a Director of a Company?

A director of the company can be found by obtaining a current or historical company extract from ASIC.

A director is also defined in section 9 of the Corporations Act to mean:

“director ” of a company or other body means:

(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

So, a director of a company can also be a shadow or defacto director, whether appointed or not.  But a liquidator would have to prove those things.

But what is a close associate of a director of the company?

What is a Close Associate of a Director of the Company?

Section 9 of the Corporations Act defines close associate of a director:

“close associate” of a director means:

(a)  a relative of the director; or

(b)  a relative of a spouse of the director.

Section 9 then goes on to define relative:

“relative” in relation to a person, means the spouse, parent or remoter lineal ancestor, child or remoter issue, or brother or sister of the person.

So, this could mean a husband, wife, defacto, mother, father, grandmother, grandfather, great grandmother, great grandfather, child, grandchild, great grandchild, stepchild, brother or sister – and possibly more.

What does on behalf of mean?

What Does “on-behalf-of” Mean?

Section 9 defines “on behalf of” to mean:

“on behalf of” includes on the instructions of

However, the cases seem to say that it was the intention of the section that the words “on behalf of” be broader than just on the instructions of.

The Explanatory Memorandum of the Corporations Amendment (Repayment of Directors’ Bonuses) Bill 2002 says:

3.8. The recipients covered are directors of the company and close associates of directors.  It also includes a person where the transaction is made on behalf of, or for the benefit of, a director or close associate.  In Commonwealth statues, references to “person” include bodies corporate.

In Vasudevan & Ors v Becon Const & Anor [2014] VSCA 14 Nettle JA (with Beach JA and McMillan AJA agreeing) said:

In the context of s 588FDA(1)(b)(iii), the requirement that a disposition be made ‘on behalf of’ a director requires something more than that it be effected on the instructions of the director. Arguably, the provenance of the section and the objectives which (according to the Explanatory Memorandum) it was designed to achieve, imply that a disposition to a person ‘on behalf of a director’ connotes a disposition which is of some benefit to the director. At the same time, however, I doubt that Parliament intended to confine the operation of s 588FDA to direct benefits or that the section should be so construed.

So seemingly, the case above says on behalf of must be of some benefit to a director, or close associate of a director.  But what does “for the benefit of” mean?

What does “for the benefit of” Mean?

Section 9 of the Corporations Act defines benefit as:

“benefit” means any benefit, whether by way of payment of cash or otherwise

So, benefit means any benefit, thanks Corporations Act!

The Oxford English Dictionary defines benefit to mean:

An advantage or profit gained from something or to receive an advantage; profit

In Vasudevan & Ors v Becon Const & Anor [2014] VSCA 14 Nettle JA (with Beach JA and McMillan AJA agreeing) said:

The natural and ordinary meaning of a requirement that something be for ‘for the benefit of’ a person is that it be ‘for the advantage, profit or good’ of the person … the natural and ordinary meaning of ‘for the benefit of’ accords to the objective of the section of preventing directors stripping benefits out of companies to their own advantage.

The Court also said:

‘benefit’ includes both direct and indirect benefits and, prima facie, that accords with the apparent objective of the section.

So, this means an advantage, profit, or good, whether by way of cash or otherwise, whether or not it is a direct benefit or an indirect benefit.

Lastly, the transaction is only an unreasonable director-related transaction if it may be expected that a reasonable person in the company’s circumstances would not have entered into the transaction.  This posits an objective test, but what have the Courts said about this objective test?

The Test for Unreasonable Director-Related Transactions

Section 588FDA(1)(c) of the Corporations Act says:

(1)  A transaction of a company is an unreasonable director-related transaction of the company if, and only if:

…

(c)  it may be expected that a reasonable person in the company’s circumstances would not have entered into the transaction, having regard to:

(i)  the benefits (if any) to the company of entering into the transaction; and

(ii)  the detriment to the company of entering into the transaction; and

(iii)  the respective benefits to other parties to the transaction of entering into it; and

(iv)  any other relevant matter.

The criteria above is calculated in the same as uncommercial transactions claims.

Read our article – Uncommercial Transactions Claims and how to Defeat Them

Section 588FDA(2) of the Corporations Act says:

(2)  To avoid doubt, if:

(a)  the transaction is a payment, disposition or issue; and

(b)  the transaction is entered into for the purpose of meeting an obligation the company has incurred;

the test in paragraph (1)(c) applies to the transaction taking into account the circumstances as they exist at the time when the transaction is entered into (rather than as they existed at the time when the obligation was incurred).

This means that the unreasonableness of a transaction must be assessed at the time when the transaction occurred, rather than the time the obligation which gave rise to the transfer occurred.

In the matter of Lawrence Waterhouse Pty Ltd (in liq) – Shaw v Minsden Pty Ltd [2011] NSWSC 964 Ward J said:

A transfer … might be voidable under s 588FDA if it is unreasonable at the time it takes place, even if it was not unreasonable when the contractual obligation to transfer the land was incurred.

If the liquidator can prove the above, then they may have a right to make an unreasonable director-related transaction claim.

However, the burden of proof is on the liquidator.  In Crowe-Maxwell v Frost [2016] NSWCA 46 Beazley P (Macfarlan and Gleeson JJA agreeing) said:

The onus of establishing that a transaction constitutes an unreasonable director-related transaction is on the party so alleging

Subject to some exceptions, if they can prove that there was a transaction, and that the transaction was an unreasonable director-related transaction, then the courts may make an order about the voidable transaction pursuant to section 588FF of the Corporations Act.

Defences to Unreasonable Director-Related Transaction Claims

More difficult to defend than the other voidable transactions, unreasonable director-related transactions claims can be beaten by stepping through the elements of the claim and ensuring the it applies.

Elements of an Unreasonable Director-Related Transactions Claim

As stated above, a transaction of a company is an unreasonable director-related transaction of the company if, and only if:

1. There is a transaction of a company; and
2. The transaction is a payment, conveyance, transfer, disposition of property, the issue of securities, and/or the incurring of an obligation; and
3. The transaction is, or is to be, made to a director of the company, a close associate of a director, or a person on behalf of, or for the benefit of, a director or close associate; and
4. It may be expected that a reasonable person in the company’s circumstances would not have entered into the transaction.

So, if the transaction is:

1. Not a transaction of a company; and
2. Not a payment, disposition or issue; and
3. Not made by a director or a close associate; or
4. Not made on behalf of, or for the benefit of, a director or a close associate; and
5. Not expected that a reasonable person in the company’s circumstances would not have entered into the transaction;

Then it might be successfully defended because the elements are not made out.

Outside the Required Timeframe

A person may also defeat unreasonable director-related transactions claims if the transaction was entered into, or an act was done for the purposes of giving effect to the transaction during the 4 years ending on the relation-back day.

Section 588FE(6A) of the Corporations Act says:

(6A) The transaction is voidable if:

(a)  it is an unreasonable director-related transaction of the company; and

(b)  it was entered into, or an act was done for the purposes of giving effect to it:

(i)  during the 4 years ending on the relation-back day; or

(ii)  after that day but on or before the day when the winding up began.

So, if the transaction was entered into, or an act was done for the purposes of giving effect to the transaction after 4 years ending on the relation-back day, then might be successfully defended.

Insolvency is not Required

Unfortunately, the defences in relation to insolvency are not applicable to unreasonable director-related transactions claims because insolvency is not an element of the claim.

In the Matter of Lesvos Pty Ltd [2012] NSWSC 1288 Brereton J said:

As the plaintiff correctly submits, a liquidator claiming relief under s 588FDA is not required to establish insolvency, and defences such as good faith and reasonable grounds are not applicable.

The Transaction was Reasonable

Another way to defend or mitigate the liquidator’s claim is to make submissions that a reasonable person in the company’s circumstances would have entered into the transaction.

Similar to the test in uncommercial transactions claims, the Courts have determined that the reasonable assessment is based on:

1. The totality of the company’s circumstances at the time of the transaction; and
2. What knowledge the director or directors of the company ought to have known; and
3. The purpose of the transaction at the time of the transaction; and
4. The business relationship of the parties at the time of the transaction.

In Cussen & Ors v Sultan & Ors [2009] NSWSC 1114 Nicholas J said:

… the court will look at the totality of the business relationship between the parties, and to what the parties under their relationship intended to effect, and how their intention was effected, in part or in whole, by the impugned transaction.

So, with this objective approach, the section also requires consideration of the benefits and detriments to the parties to the transaction.

See our article on uncommercial transactions claims here for more.

Mitigating the Liquidator’s Claim

If there are problems with successfully defending the liquidator’s unreasonable director-related transactions claims, a party may still attempt to mitigate exposure.

Section 588FF(4) of the Corporations Act says:

(4)  If the transaction is a voidable transaction solely because it is an unreasonable director-related transaction, the court may make orders under subsection (1) only for the purpose of recovering for the benefit of the creditors of the company the difference between:

(a)  the total value of the benefits provided by the company under the transaction; and

(b)  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 paragraph 588FDA(1)(c).

For example, if the company disposes of property worth $500,000.00 for $300,000.00, then the difference between what was paid, and what a reasonable company should have been paid, is the amount payable.

If you have been contacted by a liquidator in relation to unreasonable director-related transactions claims, you should contact an insolvency lawyer as soon as possible to attempt to defend the liquidator’s demand for money

GET A FREE FEE ESTIMATE TODAY

OR CALL: 1300 545 133 FOR A FREE PHONE CONSULTATION

FAQs on Unreasonable Director-Related Transactions

Navigating the intricacies of director-related transactions can be challenging, especially given the potential legal ramifications and complexities inherent in corporate governance.

This FAQ section aims to demystify the most common questions surrounding unreasonable director-related transactions, offering clear insights for both seasoned professionals and those new to the domain.

What is an unreasonable director-related transaction?

An unreasonable director-related transaction occurs when a company enters into a transaction that benefits a director or someone closely associated with them, and a reasonable person in the company’s situation would not have entered into that transaction.

Where can I find the legal details about these transactions?

Unreasonable director-related transactions are outlined in section 588FDA of the Corporations Act 2001 (CTH).

Do these transactions always relate to when the company was insolvent?

No. Unlike other voidable transactions, there’s no requirement that the company was insolvent when the unreasonable director-related transaction occurred.

What types of transactions can be considered under this category?

Payments made by the company, dispositions or issues of company property, conveyances, transfers, issue of securities, or the company incurring obligations for such activities can be considered under this category.

Who can these transactions benefit?

They can benefit a director of the company, a close associate of a director, or a person acting on behalf or for the benefit of a director or their close associate.

How do I know if someone is a director of a company?

You can obtain this information from a company extract from ASIC. Additionally, a director is not only someone officially appointed but can also be a shadow or de facto director based on their influence or actions.

What constitutes a close associate of a director?

A close associate is defined as a relative of the director or a relative of the director’s spouse, which could include immediate family members, in-laws, and possibly more.

How can one determine if a transaction was for the “benefit” of the director?

The term “benefit” is broad and means any advantage or profit, whether direct or indirect, gained from something.

How is the “reasonableness” of a transaction assessed?

It’s based on the expectation of what a reasonable person in the company’s circumstances would have done. This considers the benefits to the company, the detriment to the company, the benefits to other parties involved in the transaction, and any other relevant matter.

If I’m contacted by a liquidator about such a transaction, what should I do?

It’s recommended to contact an insolvency lawyer as soon as possible to defend against the liquidator’s demand for money.

Are there any defences available against claims of unreasonable director-related transactions?

Yes. To defend, one has to prove that the transaction doesn’t fit all the defined criteria. For instance, proving it wasn’t a transaction of the company, or wasn’t for the benefit of a director or close associate, or would have been entered into by a reasonable person in the company’s circumstances.

How can a company avoid entering into unreasonable director-related transactions?

Companies should maintain clear corporate governance standards, consult with legal professionals when engaging in transactions with directors or their close associates, and regularly audit transactions for fairness and market value.

What are the potential repercussions for a director involved in such a transaction?

Directors involved in unreasonable director-related transactions may face legal action, financial penalties, and damage to their reputation. In severe cases, they could also be disqualified from acting as a director of a company.

How long do liquidators have to pursue such claims?

Liquidators typically have a set period to commence action for voidable transactions, including unreasonable director-related transactions. This period can vary based on jurisdiction, so it’s essential to check local regulations or consult a legal professional.

Is there any difference between a de facto director and an appointed director in terms of these transactions?

In terms of liability for unreasonable director-related transactions, both de facto and officially appointed directors can be held accountable. A de facto director is someone who acts in the capacity of a director without being formally appointed.

If a transaction is deemed unreasonable, can it be reversed?

Yes, if a transaction is found to be unreasonable and voidable, it can be reversed, and the parties involved may be required to return any benefits they received.

How do these regulations impact small businesses or start-ups?

Small businesses and start-ups, where directors often wear multiple hats and engage in transactions with the company, should be especially vigilant. Such transactions should be at arm’s length and in line with market values to avoid being deemed unreasonable.

Are there any exceptions or exemptions to this rule?

The primary focus is on the reasonableness of the transaction. Certain transactions that might appear to benefit a director or associate could still be considered reasonable if they align with what a prudent person in the company’s situation would have done. Always consult with legal professionals for specific exceptions or nuances.

What role do shareholders play in these transactions?

Shareholders are not directly involved in the decision-making of these transactions, but they might raise concerns or objections if they believe a transaction doesn’t serve the company’s best interests. Vigilant shareholders can act as a check and balance against potential misuse by directors.

How common are claims regarding unreasonable director-related transactions?

The frequency of such claims varies based on corporate governance standards, industry practices, and legal enforcement. However, with increasing awareness and scrutiny of director-related transactions, it’s crucial for companies to be proactive in ensuring the fairness and reasonableness of all transactions.