Corporate insolvency and voidable transactions under the Corporations Act

Australian Corporations Act

The Corporations Act 2011 (Cth) was enacted by the Commonwealth of Australia to regulate transactions at the federal and interstate level of companies in Australia. Regulation of partnerships and managed investment schemes are also covered by the law. The "Corps' Law" may be the largest statute governing business entities in the world. Reforms were instituted in to simplify statute through passage of the Corporate Law Economic Reform Program (Audit Reform & Corporate Disclosure) Act 2004 (CLERP 9). This article provides a brief discussion of several components of the corporate insolvency legislations: Uncommercial transactions, voidable transactions, and unfair preference.

Uncommercial Transactions

Under Section 588FB (1) of the Corporations Act 2001, an uncommercial transaction is said to have occurred if "…it may be expected that a reasonable person in the company's circumstances would not have entered into the transaction…" (Warde, 2009). A Court may determine a transaction that confers no benefit or causes some detriment to a company -- which cannot be explained by what would be considered normal commercial practice -- is an uncommercial transaction (Warde, 2003).

The Court makes a decision about "whether a reasonable person would not have entered into the transaction" in question from an objective position, but the decision must be informed by a "state of knowledge of the company when it entered into the transaction" (Warde, 2003). In Capital Finance Australia Limited v. Tolcher [2007] FCAFC 185, the Full Federal Court considered if a composite set of circumstances constituted an uncommercial transaction of the debtor company, "LSE," an agent of financial companies "Capital companies") ("Addison papers," 2007). A separate financier's application disclosed fraud by the director of LSE, which resulted in mareva (asset preservation) orders against LSE ("Addison papers," 2007). In order to receive payment of several million dollars over several months, including the payout of all equipment agreements, Capital companies insisted that LSE execute a deed to that effect ("Addison papers," 2007). LSE entered liquidation several months later ("Addison papers," 2007) . The Court found that the constellation of steps, including the deed and payments transactions, were uncommercial and therefore voidable on the liquidator's application ("Addison papers," 2007). The grounds for the decision -- and the dismissal of the appeal by the Capital companies -- were that the Capital companies substantially benefitted from the transaction, that LSE executed the deed under pressure from the Capital companies, and that the deed resulted in no real benefits to LSE, and did cause significant detriment to LSE ("Addison papers," 2007).

Defenses Applicable to Uncommercial Transactions

The provisions of §588FG include defenses in favor of individuals separate from the relevant company. The Court is bound not to make an order that would materially prejudice an interest or a right of individual who is party to the transaction, under the following conditions: (1) The individual entered the transaction in good faith; (2) The individual had no reasonable grounds (or a reasonable person in those circumstances would have no reasonable grounds) for suspecting that the company was or would be insolvent; and (3) The individual changed his or her position as a result of relying on the transaction (§588FG (2)). Similar provisions exist under §588FF for an individual who is not a party to the transaction (§588FG (1)).

Unfair Preferences

Under §588FA, an unfair preference is said to be given by a company to a creditor of the company if the following conditions are in place: (1) The creditor of the company are parties to the transaction, regardless of whether someone else is also a party; (2) With respect to an unsecured debt that the company owes to the creditor, a transaction results in the creditor receiving more from the company than if the transaction was set aside and the creditor had to prove the debt in the winding-up of the company -- this holds even if the transaction occurred because of court or agency direction; (3) Stipulations with regard to the type of debt are met, such as integral part of a continuing business relationship between the creditor and the company, and a variable level of indebtedness as a result of a series of transactions; and (4) Multiple transactions shall be treated as though the constitute a single transaction.

Defenses Applicable to Unfair Preferences

In as much as the purpose of insolvency law is to provide an orderly and fair process for addressing financial arrangements that result from companies becoming insolvent, a primary consideration under the law is equal sharing between unsecured creditors. The law has been enacted to prevent companies from disposing of assets to parties who are not entitled to them or to preferring unsecured creditors in ways that confer disadvantage.

Several markers of uncommerciality can be turned into guidelines for parties entering into business transactions. The following conditions suggest to the Courts that a transaction is uncommercial: (1) A written agreement for transfer of business was not generated; (2) A purchase price cannot be ascertained; (3) No listing of creditors, liabilities to employees, equipment, or plant have been assigned; and (4) A company continues to use its bank accounts. Parties entering into transactions with companies that wish to protect themselves from unfair preference should ensure that all aspects of their business relationship and transactions that occur as a result of that relationship are in writing. A creditor-debtor relationship should include written provisions for the distribution of assets should an insolvency occur in the future. Though an insolvency clause is written in general language, it should reference that listings of assigned assets will be formally drawn by legal representation or a designated agency. Further, a party to a business transaction should seek legal counsel if it becomes apparent that it is being pressured to agree to particular settlement arrangements that convey unfair advantage or a lack of any discernable advantage to the party. In order to avoid becoming subject to the provisions of uncommercial transactions, voidable transactions, and unfair preferences as outline in the Corps Law, a party must act from an informed position. The party -- whether an individual or a business enterprise -- must carry out sufficient due diligence -- to the extent possible -- to be able to understand the state of the company with which it plans to carry out transactions.

Conclusion

Australia's Corps Law is characterized by an objective viewpoint when making decisions about business transactions. Laws in other countries take a subjective point-of-view into consideration, but in Australia, liquidators, for example, do not need to provide any evidence related to any subjective elements with regard to granting preferences in a settlement. The goal of creating a set of objective laws regarding corporate transactions has resulted in lengthy and highly specific regulations. The outcome of enacting this detailed and comprehensive law appears to be a considered approach to ensuring that Australian citizens are safeguarded in any settlement or arrangements that follow business transactions that have gone awry.