Most Unfair - the Expansion of the Uncommercial Transaction

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A recent decision of the Queensland Supreme Court, Ashala Model Agency Pty Ltd (in liq) & Anor v Featherstone & Anor [2016] QSC 121 (Ashala), may potentially widen the scope of pursuit for liquidators seeking to claw back voidable transactions under the Corporations Act 2001 (Cth) (Act).

Background

The liquidator of Ashala Model Agency Pty Ltd (Company) commenced recovery proceedings against Featherstone, the Company’s shadow director. Relevantly, Featherstone had paid himself using the Company account to clear a loan that he provided to the Company. Featherstone ultimately used that money to purchase a residential property for his de facto partner, who was also the main shareholder of Ashala. The monies paid to Featherstone rendered the Company insolvent.

The liquidator claimed that the payment to Featherstone constituted an uncommercial transaction and was recoverable under the Act. In order to successfully recover an uncommercial transaction, a number of elements must be satisfied. Section 588FB of the Act deems a transaction to be uncommercial where:

  • the company was a party to the transaction;
  • it was an insolvent transaction (that is, the transaction renders – or is likely to render – the company to become insolvent);
  • a reasonable person in the position of the company would not have entered into the transaction.

Unsurprisingly, Featherstone contended that the transaction was not uncommercial, because the Company effectively received a benefit from the reduction of the debt it owed to Featherstone.

Uncommerciality – what does a Court look at?

Traditionally, the first point of reference is to ascertain whether an identified transaction may be expected that a reasonable person in the company’s circumstances would not have entered into the transaction. The Court in Ashala recognized that one of the most common instances of an uncommercial transaction will be one which occurs at an undervalue. Adopting this approach, the Court did not consider the relevant transaction between Featherstone and the Company to be uncommercial, in that the payment to Featherstone neither improved, nor prejudiced the Company’s net asset position.

However, did this finding ultimately absolve Featherstone from liability? No!

Can an unfair preference be uncommercial?

The most common class of voidable transaction sought to be recovered by liquidators is the unfair preference. Section 588FA of the Act stipulates an unfair preference must satisfy the following elements:

  • the existence of a transaction between the company and a creditor;
  • the company must, at the time of the transaction, be insolvent; and
  • the transaction resulted in the creditor getting more than it would have, had the transaction been set aside and the creditor was to prove for that debt in a winding up.

The liquidator of the Company submitted that the effect of the payments by the Company to Featherstone was to leave the Company in a position where it was unable to make payments to the ATO. Further, the liquidator argued that the underlying purpose of the transaction was to delay or defeat the ATO as creditor.

Although the liquidator in Ashala did not press a claim for an unfair preference, the Court nevertheless considered it appropriate to consider whether an unfair preference also constitutes, or is otherwise capable of constituting an uncommercial transaction.

At the outset, the Court acknowledged that an unfair preference and an uncommercial transaction were fundamentally different in a number of ways, namely:

(a) an unfair preference turns on the result or effect of the transaction in relation to an unsecured debt, by comparing what the creditor received from the company with what the creditor would have received on a winding up, whereas an uncommercial transaction effectively involves undertaking a benefit/detriment analysis of the transaction on the company; and

(b) unfair preferences within 6 months of the relation back day are recoverable, whereas uncommercial transactions within 2 year of the relation back day are recoverable.

However, the Court maintained that there would be some cases where a transaction involving a preferential payment would possibly constitute an uncommercial transaction even though it did not necessarily entail a transaction of undervalue. It drew on a factual scenario in another case, Re Solfire Pty Ltd (in liq) [1998] 2 QD 92, which concerned directors deliberately causing the company to pay other creditors, leaving it unable to pay the plaintiff when the claim proceeded to judgment.

What then, should a practitioner look out for when considering whether to argue that a transaction that ordinarily looks preferential ought to also be argued to be uncommercial?

Circumstances where an overlap is possible

The Court in Ashala focused on the purpose underlying the relevant transaction. Specifically, the question was whether the Company became a party a transaction for the purpose of defeating, delaying or interfering with the rights of any or all of its creditors. So, the Court adopted a two-tiered test in determining whether the payment by the Company in Ashala was voidable:

1. First, it was held that Feathersone did in fact receive more than he would have if the Company was wound up and he had to prove for his debt – it therefore clearly had the effect of an unfair preference.

2. Second, the Court found that Featherstone was aware that at the time he received the payments, the ATO would remain unpaid upon the Company being wound up. So, in circumstances where certain creditors are paid first, to avoid having to pay other creditors, those transactions are now potentially open to being impugned as uncommercial and thus voidable.

Going forward

When advising liquidators in relation to potential recoverability of voidable transactions, practitioners ought to bear in mind the observations of the Court in Ashala. In situations where, for example, the relation back day becomes a relevant consideration in the pursuit of claims, one ought to consider the most appropriate characterisation of the relevant transaction. The interplay between uncommercial and unfair becomes far more blurred following the decision in Ashala. Thus, the obvious textual differences in the definitions of an unfair preference versus an uncommercial transaction become less relevant, and instead, the focus ought to shift more towards an analysis of the underlying motive and purpose behind each and every scrutinised transaction.