Understanding Voidable Transactions in Liquidation

This is the eleventh topic in a series of articles aimed at informing directors of their duties and options for small to medium enterprises if faced with insolvency. This article outlines a key aspect of investigations that a Liquidator may undertake, in their efforts to recover funds for the benefit of creditors, specifically voidable transactions entered by a Company and it’s Director(s). The Corporations Act 2001 (the Act) plays a crucial role in regulating business activity in Australia. One of its key functions is to prevent fraudulent or unfair business practices, especially during times of financial distress. Among its most important provisions are the rules concerning voidable transactions. These are transactions that a company has made but may be undone (or “avoided”) by a liquidator if the company goes into liquidation. In simple terms, voidable transactions are like "bad deals" that can be reversed when a company is in trouble, but only under specific conditions.

A voidable transaction is a payment of money, transfer of property or other transaction made from a company’s assets to a creditor, company or person (usually related to the Director), that occurs when a company is insolvent.

The most commonly pursued voidable transactions are:

• Unfair preference claims;
• Uncommercial transactions; and
• Unreasonable director-related transactions.

These voidable transactions laws matter as they protect the rights of creditors, ensuring that companies do not make rash or unfair decisions right before they collapse. If left unchecked, a few creditors could take advantage of a struggling company, leaving others with nothing.

The voidable transaction rules under the Corporations Act 2001 are like a safety net, designed to keep things fair when a company is on the brink of collapse. They ensure that no creditor gets an unfair advantage and that transactions that harm the overall financial health of a company can be reversed.

These provisions are there to maintain transparency, fairness, and to ensure that everyone involved—whether creditors, employees, or the company itself—gets a fair go in a corporate collapse.

Unfair Preference-The "Favouritism" Scenario

Section 588FA of the Act provides that a preference is a payment to a creditor for a debt that is unsecured, which results in that creditor receiving a better return than other creditors in a liquidation. Preference claims are intended to ensure the assets of an insolvent company are distributed equally among all (unsecured) creditors.

A Liquidator needs to prove the following when pursuing a preference claim:

• To prove an unfair preference claim, the appointed Liquidator must show:

  • There was a transaction between the company and an unsecured creditor;
  • The transaction occurred within 6 months of the commencement of the Liquidation for unrelated creditors and 4 years for related creditors;
  • The company was insolvent at the time of the transaction;
  • The transaction occurred within the relation back period;
  • The creditor received more than they would have in the Liquidation (that is, they received a preference); and

• The following defences, which may be available the creditor, do not apply:

  • The creditor became a party to the transaction in good faith;
  • The creditor did not have reasonable grounds to suspect the company was insolvent; or
  • The transactions were part of an ongoing account for supply and payment (running balance).

Imagine a company on the brink of liquidation but before it does, it pays off one (or a couple) of its creditors but no one else. These creditor gets a bigger slice of the pie, while others are left behind. An unfair preference occurs when a company gives preferential treatment to one (or more) of its creditors over others in a way that worsens the position of the remaining creditors.

Uncommercial Transactions- The "Wasted Money" or “Giving It Away” Scenarios

An uncommercial transaction arises when a company enters into a transaction which a reasonable person in the circumstances would not have entered into having because it:

• Has little or no benefit to and/or is detrimental to the company,
• Benefits a third party, and
• Occurs when the company was insolvent.

A liquidator needs to prove the following to recover an uncommercial transaction:

• The transaction was entered into within 2 years prior to the relation back day, or 4 years prior to the relation back day in the event the transaction is with a related entity;

• The company was insolvent at the time of the transaction, or became insolvent by entering the transaction;

• A reasonable person in the circumstances would not have entered into the transaction; and

• The following defences, which may be available the third party, do not apply:

  • The party became a party to the transaction in good faith;
  • The party did not have reasonable grounds to suspect the company was insolvent; or
  • The transaction was reasonable, having regard to the benefit received and the value of the consideration provided for the transaction.

This is what happens when a company sells an asset for less than it’s worth or transfers funds or undertakes a transaction that makes no commercial, after facing financial trouble. Picture selling a valuable piece of machinery for a fraction of its worth to a friendly or related party, potentially draining the company's resources unfairly. The key here is that the company did not receive a fair price, and it harmed creditors by reducing the pool of assets available to them.

Unreasonable Director-Related Transactions An unreasonable director-related transaction arises when a company enters into a transaction with a director or close associate, when a reasonable person in the company’s circumstances would not have entered into the transaction. It is similar to an uncommercial transaction where, the benefits and/or detriments to the company and other parties to the transaction are considered.

The key difference between an unreasonable director-related transaction and an uncommercial transaction claim by a liquidator are that:

• The transaction must involve the company, a director or close associate, or a payment on behalf of the director or close associate; and
• The Company does not need to be insolvent at the time of the transaction.

A close associate of a director is defined as:

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

Case Study Example

WCT Advisory was appointed as Liquidator of a small, property development company based in Perth and who undertook a townhouse development in Brisbane.

The Liquidator’s investigations revealed that rather than repay a loan facility, an amount of $260,000.00 was transferred from the Company to a related party (Party Co) for another development. In addition, the Director instructed the external accountant to record transactions to reduce another related party (Prop Co) loan account of $178,000 to nil in the week prior to the liquidation. An amount of $75,000 was also paid to the Director’s wife in repayment of an unsecured loan

Those transactions gave rise to several potential claims being:

• Claim against Director for breach of his duties (both common law and under Corporations Act);
• Claim against Party Co as recipient of $260,000 for an uncommercial transaction;
• Claim against Prop Co as party who benefited from $178,000 entry for an uncommercial transaction; and
• Claim against the Director’s wife for $75,000 for a preference payment and the Director for an unreasonable director related transaction.

Demand letters were issued to all parties involved and after several rounds of correspondence and two settlement conferences, an offer was received that was acceptable to the liquidators to settle all claims resulting in a substantial dividend to creditors after the costs involved in the recovery actions.