How Voidable Transaction Claims Work During Company Liquidation

The Corporations Act 2001 (the Act) gives Liquidators a wide range of powers during a company Liquidation. Once appointed, their role is to assess your company’s financial situation, sell its assets, investigate its affairs and divide the proceeds fairly to all parties involved. As part of the Liquidator’s investigations, the Act gives a Liquidator the ability to set aside certain transactions entered into by the company when it was insolvent. These are referred to as voidable transactions.

This means a Liquidator can demand payment from a creditor or other party who received payments or property from your company before it entered Liquidation. If warranted, the Liquidator may further pursue the claim through legal action in court to recover money for the benefit of your company’s creditors.

What is a Voidable Transaction?

A voidable transaction is a payment of money, transfer of property or other transaction made from your company’s assets to a creditor, company or person (often related to the director), that occurs at a time when a company is insolvent. Additionally, transactions may be voidable which occur when a company is not insolvent, but they cause harm to the company.

If your company is insolvent, it means that not all creditors will be paid their debts in full. As a director, you have a responsibility to fairly deal with your company’s assets while ensuring no creditors are being unfairly advantaged or disadvantaged. Out of temptation or desperation, directors in these circumstances may take advantage of their position to benefit themselves, a related party or a creditor. However, the Act seeks to prevent such action under the voidable transaction and other provisions. If a voidable transaction has taken place and the Liquidator successfully proves the voidable transaction claim, the Court may order the recipient of the payment or property to return it to the Liquidator, or return the value of the benefit received.

The most common voidable transactions are:

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

If you are a director of a company which may be insolvent, you can be personally exposed if you cause your company to enter such a transaction. It’s therefore important to understand how these claims arise and what you can do to avoid them.

What are Unfair Preference Payments?

Unfair preference claims are the most common type of voidable transaction. An unfair preference payment involves a creditor of the company (a person or business owed money) and results in the creditor receiving a better return than other creditors in the Liquidation.

• To prove an unfair preference claim, the appointed Liquidator must show:
• There was a transaction between your company (now in Liquidation) and a creditor,
• The transaction occurred within 6 months of the commencement of the Liquidation for unrelated creditors and 4 years for related creditors,
• Your company was insolvent at the time of the transaction,
• The transaction occurred within the relation back period, and
• The creditor received more than they would have in the Liquidation (that is, they received a preference).

Preference claims are intended to ensure the assets of an insolvent company are distributed equally among creditors. But if the appointed Liquidator has actioned a claim against a creditor, there are a number of defences to protect creditors where they:

• Become a party to the transaction in good faith,
• Did not have reasonable grounds to suspect your company was insolvent,
• Had a valid PPSA security interest in respect of their debt, or
• Transactions were part of an ongoing account for supply and payment.

Preference claims often arise against trade creditors whose debts blow out and then cut off supply, the director and their related parties whose loans are repaid and the Australian Taxation Office (ATO). Such payments will often be large amounts, to prevent legal action by a creditor or to repay some of the director’s investment to support the company. But before making these payments, which can leave your company short of cash, it’s important to consider the risk of the payment being recovered, if the company fails. There may be a better way to help your company survive or protect your investment.

What are Uncommercial Transactions?

Uncommercial transactions arise when a company enters into a transaction or agreement which:

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

An example of an uncommercial transaction would be the transfer or sale of a company’s business or assets for no consideration or for less than fair value. If such a transaction occurs, a Liquidator can claim the value of the benefit received from the recipient of the property or benefit.

To recover a transaction as an uncommercial transaction, the appointed Liquidator must establish:

• 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 of your company,
• Your company was insolvent at the time it entered into the transaction, or it became insolvent by entering the transaction, and
• It may be expected that a reasonable person in your circumstances would not have entered into the transaction.

Entities are protected by the law when dealing with your company in a scenario where they:

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

What are Unreasonable Director-Related Transactions?

An unreasonable director-related transaction arises when a company enters into a transaction with a director or close associate, in circumstances where it may be expected that a reasonable person in the company’s circumstances would not have entered into the transaction. Similar to an uncommercial transaction claim, the benefits and/or detriments to the company and other parties to the transaction, are considered when determining whether it is voidable.

The key differences between an unreasonable director-related transaction and an uncommercial transaction claim are that:

• An unreasonable director-related transaction must involve the company, a director or close associate, or a payment on behalf of the director or close associate,
• For the transaction to be voidable, the company does not need to have been insolvent at the time, and
• The relation-back period within which such a transaction may be voidable is 4 years.

As a company director, you need to be aware of the transactions between your company, its creditors, other parties and you may come under scrutiny if a Liquidator is appointed. If you have any questions on voidable transactions or need some advice specific to your individual circumstances, get in touch with Revive Financial on 1800 861 247 today. Obtaining the right advice at the right time can help protect you and your business.

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