Litig8: Insolvency: Evidence of director related transactions

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By Jason Kalliris, Law Graduate

Each month as a part of Mills Oakley’s Litig8, we bring to you snapshots of eight key cases, legislative changes or other legal events. The summaries are not comprehensive and do not constitute legal advice. You should seek professional advice before taking any action based on the content of this email.

Part 6 of the May edition of Litig8

In Crowe-Maxwell v Frost [2016] NSWCA 46 (16 March 2016), the New South Wales Court of Appeal provided a useful summary of the elements and proof of a claim by a liquidator for the recovery of payments alleged to constitute unreasonable director-related transactions within the meaning of s 588FDA of the Corporations Act, 2001 (Cth).

The material facts of the case are as follows:

  • Mr and Mrs Frost (respondents) operated a childcare business through the second appellant corporation (Company) of which they were sole shareholders and directors. Mr Frost operated the Company on a full-time basis while Mrs Frost worked there on a casual basis.
  • In the running of the Company, the directors failed to keep the Company’s expenses and their personal finances separate. The Company’s books of account were also not properly kept. There was no record in the Company’s books of any payment of wages to the respondents.  Evidence revealed that the Company had paid personal expenses that the respondents had incurred.
  • From 2005, the Company’s financial circumstances began to deteriorate. On 19 November 2008, an application was lodged to wind up the Company. An order for its liquidation was made on 12 March 2009, with the first appellant being appointed as liquidator.
  • The liquidator sought to recover payments made by the Company for the director’s benefit on the basis that such payments constituted unreasonable director-related transactions within the meaning of section 588FDA of the Corporations Act 2001 (Cth).

The judge at first instance dismissed the claims made by the liquidator, finding that the payments made did not provide a benefit to the directors beyond their entitlement to be paid for their services and were not uncommercial.

On appeal, the essential question was whether the monies claimed were unreasonable director-related transactions within the meaning of section 588FDA of the Corporations Act 2001 (Cth).

Relevantly, in reaching its decision, the Court was required to address issues regarding the liquidator’s onus of proving that a transaction constituted an unreasonable director related transaction and the extent to which directors bore an onus to adduce evidence.

The Court accepted that the payments were not unreasonable director-related transactions. A lack of contractual relations in relation to remuneration for services between the Company and the respondents was not enough. Such inquiries must be centred on whether the payment was an unreasonable director-related transaction.

The Court observed:

  • The existence of a contractual relationship may assist in illustrating the respective benefits and detriments contemplated by section 588FDA(1)(c)(i)-(iii), however, it is not determinative of whether a payment constitutes an unreasonable director-related transaction;
  • Almost invariably, the onus of establishing that a transaction is an unreasonable director-related transaction is on the party alleging this to be the case. However, the defendant director may bear an evidentiary onus of raising some commercial explanation for a transaction where there is limited evidence of the nature or purpose of the transaction, but surrounding circumstances illustrate that it is a departure from normal commercial practice, absent some commercial explanation;
  • Impropriety or a breach of a director’s duty is not necessary in establishing an unreasonable director-related transaction;
  • The inquiry under section 588FDA(1)(c) is concerned with the reasonableness of the company’s conduct, objectively assessed;
  • The inquiry under section 588FDA(1)(c) is conducted by reference to the company’s circumstances, encompassing all relevant matters;
  • Normal commercial practice is relevant but not determinative in conducting the section 588FDA(1)(c) inquiry;
  • The natural and ordinary meaning of the requirement that something be “for the benefit” of a person is that it be “for the advantage, profit or good” of the person. This meaning accords with the objective of the section which is to prevent directors stripping benefits out of companies to their own advantage; and
  • A transaction of derivative benefit only can still be for the benefit of the company.

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