Clipping the phoenix’s wings – Court consideration of creditor-defeating dispositions

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By Mark Wenn, Partner, Alex Myers, Senior Associate and Eliza Nugent, Lawyer

Introduction

In early 2020, the Corporations Act 2001 (Cth) (Act) was amended to introduce new provisions intended to combat illegal phoenix activity,[1] which typically involves the transfer of a company’s business and other assets to another (usually newly incorporated) entity (often with a similar name) for no or inadequate consideration.

Included in the new suite of provisions was section 588FDB of the Act, which took effect on 18 February 2020. Section 588FDB is headed “Creditor-defeating disposition”, and is a new kind of voidable transaction a liquidator may seek to unwind following his or her appointment to a company. Section 588FDB of the Act states as follows

(1) A disposition of property of a company is a creditor‑defeating disposition if:

(a) the consideration payable to the company for the disposition was less than the lesser of the following at the time the relevant agreement (as defined in section 9) for the disposition was made or, if there was no such agreement, at the time of the disposition:

(i) the market value of the property;

(ii) the best price that was reasonably obtainable for the property, having regard to the circumstances existing at that time; and

(b) the disposition has the effect of:

(i) preventing the property from becoming available for the benefit of the company’s creditors in the winding‑up of the company; or

(ii) hindering, or significantly delaying, the process of making the property available for the benefit of the company’s creditors in the winding‑up of the company.

Re Intellicomms Pty Ltd (In Liq) [2022] VSC 228 (Re Intellicomms) is the first (and, at the time of writing, the only) authority that has considered section 588FDB of the Act.

Re Intellicomms involved the disposition by Intellicomms Pty Ltd (Company) of certain business assets (Assets) immediately prior to the Company being wound up, under an agreement (Sale Agreement) that the Court described as having “…all the hallmarks of a classic phoenix transaction…”.

It was not in dispute in Re Intellicomms that the:

  1. Sale Agreement prevented the Company’s property from becoming available for the benefit of its creditors in the winding up (as section 588FDB(1)(b) requires); or
  2. Company and Technologie Fluenti Pty Ltd (TF), the purchaser of the assets, entered the Sale Agreement when the Company was insolvent (satisfying one of the scenarios in section 588FE of the Act where a creditor-defeating disposition is voidable).

Ultimately, the key question in Re Intellicomms was whether the liquidators had established that the amount payable under the Sale Agreement was less than the lesser of the market value and the best price reasonably obtainable for the assets sold (within the meaning of section 588FDB(1)(a) of the Act), and, if so, whether the relief the liquidators sought should be granted.

Accordingly, much of the case turned on various valuations of the Company and its business that had been carried out at different times. The circumstances in which the Company entered the sale agreement were also seen as relevant to the valuation question.

The decision suggests that liquidators may not need to adduce expert evidence containing a specific opinion as to the value of assets disposed as part of an alleged creditor-defeating disposition to establish their claim. It also establishes that the optics of and circumstances surrounding the transaction are relevant to the valuation question (particularly the best price that was reasonably obtainable for the assets, as per subsection 588FDB(1)(b) of the Act).

Background

The Company operated a business that provided translation services to commercial entities and Government departments, in both Australia and New Zealand (the latter through a wholly owned subsidiary, Intellicomms NZ Ltd (Intellicomms NZ)).

The Company derived roughly 85 per cent of its revenue from seven key customers. It had 11 employees (including four members of the director’s family), and engaged the services of around 700 subcontractors to perform translation services. The Company’s key assets included trademarks, a website, its business name “ezispeak”, its proprietary online translation software, major customer contracts, agreements with subcontractors, and its shareholding in Intellicomms NZ.

To operate the online aspects of its translation business, the Company used software developed by Callsacan Australia Pty Ltd (QPC), for which it paid a monthly fee. QPC and the Company had a longstanding relationship, with QPC also being a minority shareholder in the Company.

By early 2021, the Company owed QPC approximately $755,209. The parties commenced discussions regarding how the Company could pay the debts it owed to QPC over a three-year period. One aspect was a proposal by the Company that it issue additional shares to QPC.

In late July 2021, the discussions broke down. A short time later, on 17 August 2021, QPC served a statutory demand upon the Company, seeking payment of $923,310.

On 25 August 2021, TF was incorporated. Its sole director and shareholder was the Company’s financial and payroll administrator, who was also a sister of the Company’s only director.

On 8 September 2021, the Company and TF entered into the Sale Agreement, the key features of which were as follows.

  1. The assets sold included the “business”, which the Sale Agreement defined as “the business of providing interpreting and translation services to clients in Australia and New Zealand”, as well as certain other assets of the Company.
  2. The further assets sold comprised the Company’s business records, goodwill, intellectual property, shares (including those in Intellicomms NZ), office equipment, and computers, as well as certain computer hardware and telephone numbers.
  3. The Company assigned its contracts with principal customers and subcontractors to TF, and transferred identified employees to TF – the latter occurred on the basis that TF would assume liability for the transferring employees’ entitlements.
  4. Aside from the entitlements of the transferring employees, TF did not assume any of the Company’s other liabilities, which totalled more than $3.2 million.
  5. Completion under the Sale Agreement would not proceed unless and until all necessary contracts and licences were transferred on terms satisfactory to TF and any security interested registered on the PPSR were released.
  6. The purchase price payable by TF was defined as $102,000, subject to various potential adjustments in TF’s favour – these included sums of $37,272.82 for entitlements of the employees transferred to TF, and a reduction in the base purchase price to $58,000 if certain material contracts were not assigned or novated.

The liquidators’ view was that the amount ultimately payable by TF under the Sale Agreement was $20,727.17, after undertaking the required adjustments.

On 8 September 2021, the Company convened a directors’ meeting, at which resolutions were passed that the Company be wound up and that liquidators be appointed.

Value of assets sold and related evidence

Prior to the Company and TF entering the Sale Agreement, several valuations of the Company were prepared, which are summarised as follows:

  1. a valuation prepared in February 2021 (February Valuation). The February Valuation opined that the fair market value of the equity in the Company was $11,277,346, as at 30 June 2020. It was prepared to assess the market value of the Company’s equity for the purpose of a possible share issue;
  2. on 26 July 2021, a valuation of the Company was conducted as of 30 June 2021 (July Valuation). The July Valuation expressed the view that the fair market value of the equity in the Company was $117,456 to $683,559. It was also prepared to inform a potential share issue in lieu of loans provided by shareholders to the Company;
  3. on 30 August 2021, a further report ascribed a value of $101,000 to the goodwill in the Company’s business (August Valuation). TF’s evidence contended that the purpose of the August Valuation was “to ascertain the market value of ezispeak and associated assets to be acquired by TF from [the Company]”. The valuer appeared to have been instructed to exclude from the valuation all revenue derived from New Zealand based customers; and
  4. on 8 September 2021, (being the date of the Sale Agreement and the subsequent winding up of the company), a revised report by the same valuer as the August Valuation valued the goodwill in the Company’s business at $57,000, based upon the loss or potential loss of significant contracts (September Valuation). The September Valuation was prepared on the same basis as the August Valuation, save for revised cash flow forecasts forming part of the valuer’s instructions.

TF contended that August Valuation as supplemented by the September Valuation was relied upon to calculate the Sale Agreement purchase price. TF also relied upon a further valuation prepared for the purposes of the proceeding (TF Proceeding Report). The TF Proceeding Report assessed the market value of the Assets to be $22,925 as at 8 September 2021, and stated it was not possible to form a view as to the best price reasonably obtainable for the Assets, but that that value would not be more than the market value of the assets sold.

The liquidators also obtained an expert report (Liquidators’ Report), which did not contain an opinion as to the value of the Company, its business, or the Assets, but identified asserted deficiencies in the reports that TF relied upon.

Parties’ submissions

The liquidators submitted that they were not required to establish an actual monetary value for the market value of the Assets and the best price reasonably obtainable for them, and that in any event, the Court had sufficient evidence to determine their value. It was also submitted that the Assets had a value exceeding the figures in both the September Valuation and the TF Proceeding Report, principally based on the asserted deficiencies the Liquidators’ Report had identified.

The liquidators also submitted that the fact QPC’s director was willing to purchase the Assets for between roughly $500,000 and $1 million was relevant, as were assertions that the Company’s director had procured the August Valuation using more pessimistic cash flow forecasts than were utilised for the July Report, prepared a month earlier.

Regarding the best price reasonably obtainable for the Assets, the liquidators submitted that there was no reason for this amount to be less than their market value, primarily based on the absence of any attempt to market or sell the Assets to arm’s length third parties.

TF submitted that the liquidators were required to adduce sufficient evidence to enable the Court to determine an actual monetary value as at 8 September 2021, for both the market value of the Assets, and the best price reasonably obtainable for them. It was also submitted that the only admissible evidence as to the market value of the Assets was the TF Proceeding Report, and that the Court should accept the conclusions in it.

Finally, TF submitted that there were two limbs to section 588FDB of the Act, such that both the market value of and best price reasonably obtainable for the assets disposed of must be established if the transaction is to be classed as a creditor-defeating disposition.

Court’s decision

The Court determined that the Sale Agreement “…had all the features of what has become known as a phoenix transaction”, and that its effect was to place the Company’s assets into the hands of a closely associated entity, beyond the reach of the Company’s creditors. It was noted that TF had not explained the apparent urgency with which the Sale Agreement proceeded or why any sale could not be left to a liquidator appointed to the Company. Additionally, the Court saw as relevant the absence of any evidence that the Company had considered appointing an administrator to oversee an orderly sale of the Assets for creditors’ benefit.

The Court also held that:

  1. the Company did not seek to pursue an open market sale of the Assets whilst negotiations were taking place as to a potential capitalisation of the Company’s debt owed to QPC (its largest creditor) – instead, the sale to TF occurred in a clandestine manner that deprived QPC of an opportunity to purchase the Assets, which the Court considered would have occurred for a higher price than that which TF ultimately paid;
  2. QPC’s funding of the liquidators’ proceeding (which TF alleged had occurred with an improper or ulterior motive) was not inappropriate, notwithstanding its interest in purchasing the Assets;
  3. it was not necessary for the liquidators to adduce evidence to enable the Court to determine an actual monetary value as to the market value and best price reasonably obtainable for the Assets, in order to establish that the consideration that TF paid for them was less than the lesser of these two amounts, as s 588FDB(1) of the Act required;
  4. instead, it was sufficient for the liquidators to establish on the balance of probabilities that the consideration payable under the Sale Agreement was less than both of the amounts section 588FDB(1) of the Act described;
  5. the criticisms that the Liquidators’ Report made of the TF Proceeding Report had considerable force – whilst it was said to be impracticable to quantify the acceptance of the criticisms on the report’s conclusions as to value, the Court was prepared to find (on the balance of probabilities) that the market value of the Assets significantly exceeded the value the report had ascribed to them;
  6. although the true market value of the Assets was not tested, the evidence indicated that they had a special or unique value to QPC, given its willingness to purchase them; and
  7. given the circumstances in which the Sale Agreement was entered into, the best price reasonably obtainable for the Assets was not less than their market value, such that the price paid for the assets was also less than that amount.

In the circumstances above, and as the remaining elements of sections 588FDB and 588FE of the Act were not in contention, the Court determined that the Sale Agreement was a voidable creditor-defeating disposition.

Conclusion

Section 588FDB(1) of the Act requires (amongst other things) the consideration payable for property a company disposes of that is alleged to be a creditor-defeating disposition to be less than lesser of two prescribed values (market value, and the best price reasonably obtainable, having regard to the circumstances existing at the time of the disposition).

Intellicomms took the view that it was not necessary for the liquidators to adduce admissible evidence establishing the actual monetary value of the assets transferred, so that this could be compared against the two value/pricing thresholds section 588FDB(1) of the Act prescribes. The Court was prepared, in the absence of such evidence from the liquidators, to find on the balance of probabilities that the amount payable for the Assets was too low.

However, this conclusion appears (at least to some extent) to have had its genesis in admissible evidence as to value (being the TF Proceeding Report). In any case, there would likely be practical difficulties in a Court determining that the consideration payable for an asset was less than the two prescribed amounts in a scenario where there was a complete absence of any admissible evidence as to their value.

The willingness of a prospective purchaser of the assets transferred may be a relevant factor in determining whether the amount ultimately paid for them was less than the lesser of the two prescribed amounts. This is so even if the purchaser arguably stands to gain from the transaction being declared void as a creditor-defeating disposition through an opportunity to purchase the assets from a liquidator. These matters appear likely to inform the Court’s assessment of the best price reasonably obtainable, having regard to the circumstances existing at the time of the transaction (as subsection 588FDB(1)(b) of the Act prescribes).

Finally, the optics of a transaction attacked as a creditor-defeating disposition and the conduct of those involved may also be relevant to the determination that the consideration payable was less than the lesser of the two prescribed amounts.

The Court made various observations regarding the timing of the transaction, the conduct of the Company’s director in obtaining what were described as increasingly pessimistic valuations, and the effect of the Sale Agreement being to place the Assets beyond the reach of creditors. These matters also appear to be pertinent when determining the best price reasonably obtainable for the assets the subject of the impugned disposition.

[1] Explanatory Memorandum, Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020 (Cth), 5 [1.3].

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