A recent decision of the Queensland Supreme Court, Ashala Model Agency Pty Ltd (in liq) & Anor v Featherstone & Anor  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) in a liquidation.
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 Company was either insolvent at the time of the payments, or was rendered insolvent by the monies paid to Featherstone.
During the recovery proceedings, the liquidator claimed that the payment to Featherstone constituted an uncommercial transaction and was therefore 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); and
- 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 it may be expected that a reasonable person in the company’s circumstances would not have entered into the transaction in question. The Court in Ashala recognised 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, not 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 during a liquidation 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.
Interestingly, the liquidator in Ashala chose not to claim for an unfair preference, a point which Featherstone used in his defence. Although immaterial to the liquidator’s pleaded case, 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 years of the relation back day are recoverable.
It was the Court’s finding that the definitions of an unfair preference and an uncommercial transaction given in the Act were not intended to overlap, in that an unfair preference, without something more, could constitute an uncommercial transaction. 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)  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 to 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:
- First, it was held that Featherstone 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.
- Second, the Court found that Featherstone was aware at the time he received the payments that he would be paid as a creditor, leaving the ATO and other creditors to remain unpaid upon the Company being wound up.
The Court found that in making the payments, the Company became a party to the transaction. As shadow director, Featherstone caused the Company to make payments with the purpose to defeat, delay or interfere with other creditors. 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.
There has, to date, been no further judicial consideration of the judgment delivered by the Courtin Ashala. So, for now, the decision can be viewed as potentially setting a new standard for the scope of uncommercial transactions. Expanding this scope and cementing the suggestions put forth in earlier cases such as Re Solfire will no doubt affect future cases regarding preferential payments to creditors. When advising liquidators in relation to potential recoverability of voidable transactions, practitioners now 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.
Partner, Edwards Mac Scovell