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Director-Related Transactions: Are they reasonable?

8 June 2017

A company is a separate legal entity from its Director however the nature of the relationship often means there are financial transactions between a company and a Director, usually through a loan account recorded in the company’s accounts.  In the ordinary course of business there may be loans to or from a Director and other expenses paid by one party on behalf of the other.  The issue arises if the company becomes insolvent and the Director (or an associate) has received the benefit of transactions in the 4 year period prior to the company’s winding up which was to the detriment of the company and ultimately, other creditors of the company in the winding up.

There are provisions in the Corporations Act that allow an insolvent company’s Liquidator to recover property or compensation for the benefit of creditors.  Certain transactions entered into by the company may be deemed to be ‘voidable’.  Unreasonable director-related transactions are a type of voidable transaction.

What is an unreasonable director-related transaction?

Section 588FDA of the Corporations Act deals with unreasonable director-related transactions and provides that a transaction 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.

Any Director that has received a reduction of a loan account owed to him/her may be at risk of being required to repay amounts received if the company is wound up within 4 years of any transactions being made. 

An unreasonable director-related transaction gives a Director (or associate) an advantage over other creditors of the company as they have received a benefit whilst other creditors may have received nothing.  If all creditors were to prove in the winding up, they may (depending on the availability of company assets for distribution) receive a cents-in-the-dollar return which results in a payment proportional to the quantum of their debt.

Timeframe for recovery of an unreasonable director-related transaction

To determine if any unreasonable director-related transactions are voidable, a Liquidator will calculate what is known as the Relation-Back Period for the company.  Any payments made during this period that are unreasonable director-related transactions will be voidable and may be recoverable by a Liquidator.

The Relation-Back Day is determined as, if the company was previously in voluntary administration, the date of administration.  If there was a winding up order against the company prior to the date of voluntary administration, in this instance the relation back day will be the date the earlier winding up application was filed.  Otherwise the earlier of the date of the filing of a winding up application and the date the members resolve to wind up the company.

Section 588FE(6A) of the Corporations Act specifies that an unreasonable director-related transaction is a voidable transaction if it was entered into, or an act was done for the purposes of giving effect to it:

  • During the 4 years ending on the relation-back day; or
  • After that day but on or before the day when the winding up began.

In summary, any unreasonable director-related transactions made to a creditor during the 4 year period prior to the relation-back day, will be a voidable transaction and may be recoverable from a creditor by the Liquidator.

How will a Liquidator recover an unreasonable director-related transaction?

Once a Liquidator has identified an unreasonable director-related transaction that is a voidable, he/she will request the Director (or associate) to repay the amount to the company.

A Liquidator may apply to the Court for an Order.  If the court is satisfied that a transaction of the company is voidable because of Section 588FE, the Court may make an order under Section 588FF of the Corporations Act.

The funds recovered by the Liquidator will be added to the pool of company assets and used to make a cents-in-the dollar distribution to all creditors of the company, so each creditor will receive a return proportional to the amount of their debt.

Action

If you are a director of a company, you need to be aware that transactions between you and the company may come under scrutiny if a Liquidator is appointed to the company.  A Liquidator has the right to recover any voidable unreasonable director-related transactions from you (or your associate) that occurred in the 4 years prior to the winding up of the company. 

If you have any queries in relation to what constitutes an unreasonable director-related transaction, or if you would like advice in relation to your specific business circumstances, contact Rodgers Reidy now for a confidential discussion.  Obtaining the right advice at the right time can help protect your business and personal financial position.

Further resources:-

1.        ASIC Information Sheet 42 – Liquidation: A Guide for Directors

 

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