An Overview of Unreasonable Director Related Transactions

Liquidators have several weapons at their disposal for recovering money or assets that have been removed from a company before it goes into external administration.

One recent and powerful addition to the liquidator’s arsenal is the Unreasonable Director Related Transaction (referred to in this article, for the sake of brevity if not elegance, as the UDRT).

Early this century there was public outrage at the bonuses which the directors of One.Tel paid to themselves before that company collapsed. Federal Parliament’s response in 2003 was the Corporations Amendment (Repayment of Director’s Bonuses) Act 2003, which was said to be aimed specifically at providing a way to recover bonuses paid to the directors of failed companies.  In practice the application of the new powers has been quite different, and far wider.

The 2003 Act introduced section 588FDA to the Corporations Act. The new section applies to transactions between a company and a director of the company or a “close associate” of the director. It also applies to transactions involving the company, and third parties acting on behalf of a director or close associate.

Liquidators can establish that a transaction is a UDRT if they can show that a reasonable person in the company’s position would not have entered into it after weighing up the benefits and detriments to the company, the benefits gained by others, and “any other relevant factor”. Once this unreasonableness is established, the liquidator has a range of options under section 588FF to recover the money or property transferred, or to otherwise relieve the company of the burden of the UDRT.

Until recently it was relatively easy to defeat a claim for a UDRT when third parties were involved, because a liquidator had to show that the transaction was for the “direct” benefit of the director or close associate, and for a time the courts held that this benefit must be very direct indeed. In one case [1] the director of a company used its money to purchase properties for another company, of which he was the sole director and shareholder.  The enrichment of the second company was held to be an insufficiently “direct” benefit to the director, notwithstanding that he was the only shareholder, so the liquidator’s attempt to establish a UDRT failed.

This restrictive interpretation of “benefit” has recently changed. In Vasudevan v Becon Construction & Anor [2014] VSCA 14, a director caused his company to assume liability for, and to secure, a debt for which he was personally liable.  The Victorian Court of Appeal overturned the earlier authorities and held that the whole point of section 588FGA was to capture both direct and indirect benefits. The benefit to the director in this case was indirect, but obvious, and the Court of Appeal found that it was a UDRT.

A different problem for liquidators was identified in a more recent Western Australian decision, Weaver v Harburn [2014] WASCA 227, where the director caused his company to pay the purchase price for a boat bought by the director’s partner.

It was a fairly clear misuse of the company’s funds. But the Court of Appeal found that it could not make orders against the director under section 588FF to undo the transaction because the director was not a party to the contract, which was between his partner, the company and the vendor of the boat.

However the director’s partner was a party to the transaction and did have orders made against her pursuant to section 588FF. And the Court of Appeal had no difficulty in finding that the director had breached his duties to the company.  He was ordered to pay compensation to the company for the breach in the amount of the purchase price.

Although claims to recover UDRTs can be beset by technicalities, they remain an attractive option for liquidators in the right circumstances. They apply to transactions entered into up to 4 years prior to the date of commencement of the liquidation [2] and, unlike most of the liquidator’s weapons in Part 5.7B of the Corporations Act, it is not necessary to prove that the company was insolvent at the time of the transaction to show that it is a UDRT.

The defences to a UDRT claim are more limited, partly because insolvency is not an element. This is more good news for liquidators but not so much for banks, purchasers and other third parties who may find themselves unwittingly involved in the transaction, whether it be an obvious asset stripping exercise or apparently straightforward sale or conveyance.  An important feature of a UDRT is that does not have to be unlawful or improper.  A perfectly legitimate transaction will be a UDRT if a reasonable person would not have entered into it having regard to the aforementioned benefits and detriments to the company, benefits gained by others, and “other relevant factors”.

However a liquidator pursuing a UDRT may not be able to completely undo the transaction. Generally the liquidator will only be entitled to recover the difference between the amount paid or conveyed by the company and the real value of the benefit received by the company.  In Lyngray Developments Pty Ltd (In Liquidation) v Dushas & Anor [2013] QCA 55 the Queensland Court of Appeal demonstrated a willingness to take into account very slight evidence of benefits gained by a company in order to reduce a liquidator’s claim for a UDRT.

Somewhat ironically, it is very difficult to find a UDRT case that actually relates to the repayment of director’s bonuses. In a recent case in the New South Wales District Court [3], the liquidators sought to recover amounts of money that were regularly pulled out of a company by its directors with no real attempt to account for them.  In fact the company’s records generally were in a very poor state.  But the directors were able to convince the court that, because these payments were in lieu of wages which they hadn’t been paid, the payments were not in fact unreasonable in the circumstances.

But while UDRT claims have rarely been successfully aimed at the target for which they were originally designed, they remain a powerful instrument for liquidators. It behoves directors and those dealing with them and advising them to thoroughly understand how to ensure that a transaction will not one day become a UDRT.

For more information about this Update or any Insolvency related matter please contact us on (08) 9321 3755.  .

The information published in this paper is of a general nature and should not be construed as legal advice. Whilst we aim to provide timely, relevant and accurate information, the law may change and circumstances may differ. You should not therefore act in reliance on it without first obtaining specific legal advice.

[1] Re Great Wall Resources Pty Ltd (in liq) [2013] NSWSC 354

[2] Strictly speaking the Relation-Back Day

[3] I & K Frost Pty Ltd (in liq) v Frost [2014] NSWDC 193