A transaction made by a business that shortly goes into insolvency after the transaction can be voidable. The voidable transaction by the business in distress can include the payment of money or transfer of property.
For example, imagine that a business has not paid their goods supplier for the last three months. After a formal notice from the supplier, the business pays back all the money that was due. Two months after the payment, the business goes into liquidation. Liquidators of an insolvent company are able to set aside the voidable transaction that occurred with the insolvent company. They can then demand the return of money paid. As a result, the supplier receives a letter of demand from the liquidator. The liquidator claims that the payment for the goods is voidable and should be returned.
From a common sense perspective, the ability of the liquidator to claim back the money seems odd. The company owes the money to the supplier. The supplier has also not committed any wrongful acts. However, the rationale is that the supplier should not be placed above other creditors. The insolvent may have several creditors. The creditors might have secured interests that give them a higher priority to the company’s money. It would be unfair other creditors with secured interest are left completely empty-handed because the supplier is paid fully. This rule also prevents insolvent businesses from using all of their cash to pay shareholders and directors.
Criteria of a voidable transaction
The Corporations Act 2001 (Cth) regulates and controls ‘voidable transactions’. Section 588FE of the Corporations Act sets out different ways a transaction may be classified as a ‘voidable transaction’.
A voidable transaction requires an ‘insolvent transaction’. An ‘insolvent transaction’ is a transaction that gives an ‘unfair preference’ or is an ‘uncommercial transaction’. The transaction must be made when the company was insolvent or the company becomes insolvent because of the transaction. If the transaction was made before insolvency, it must have occurred sometime in the 6 months before the ‘relation-back day’. The ‘relation-back day’ is the day the company enters into insolvency.
Unfair Preference
An ‘unfair preference’ is a situation similar to the example discussed above. It involves an unsecured creditor receiving more money than they would have if they had to prove their claim. Unsecured creditors can be subject to claims for ‘unfair preference’. This demonstrates the importance for creditors to secure their interests through the PPSR. You can find more comprehensive information on the PPSR here.
Uncommercial Transaction
An ‘uncommercial transaction’ is a transaction that a reasonable person in the company’s shoes would not enter into. This may be because it is detrimental to the company, provides no benefits, severely benefits the other party, or any other matter.
Transaction Period for Insolvent Transactions
Notably, in specific circumstances, an ‘insolvent transaction’ may be voidable even if it did not occur in the 6 months prior to the ‘relation-back’ day. The Corporations Act sets out various transaction periods for various voidable transactions. A transaction that is both an ‘insolvent transaction’ and a ‘uncommercial transaction’ has a transaction period of 2 years from the relation-back day. An ‘insolvent transaction’ conducted with a related entity of the company has a transaction period of 4 years. An ‘insolvent transaction’ that purposefully interferes with the rights of other creditors has a transaction period of 10 years.
Other Transactions
An administrator must approve the transactions of a company when it is insolvent. A transaction that is not approved by the administrator can be voidable. This may also occur for transactions that are conduct on the day the company decides to being winding up. This can include transactions that give an ‘unfair preference’, are ‘uncommercial transactions’, create an ‘unfair loan’ to the company, or an ‘unreasonable director-related transaction’.
Unfair Loan
A loan is unfair if the amount is ‘extortionate’ or the interest rate charges on the loan are extortionate. A loan is ‘extortionate’ based on the circumstances. A court may consider the loan amount, the risks of the loan, the security taken for the loan, the term of the loan, and the schedule for the payment of the loan.
Unreasonable Director-Related Transaction
This includes any transfer of money, property or securities by the company to its director, a close associate of the director, or a person acting on behalf of the director. A reasonable person in the company’s shoes must not have made the transaction.
Court Order
Once the criteria of a voidable transaction is demonstrated, the court can make an order requiring the repayment of the amount, return of the property, pay any benefits received by the party, discharge a security on the insolvent company’s asset, or set aside a loan.
Defences to a voidable transaction
If you receive a letter of demand from the liquidator, there are certain defences set out in section 588G of the Corporations Act that you can rely on to prevent the repayment of money. Largely, the defence involves (1) showing that the transaction was made in good faith, (2) the person had no reasonable grounds for suspecting that the company would be insolvent or would become insolvent, and (3) a reasonable person would not be suspicious either.
It is also significant if you gave something valuable in return for the payment or have had a change of position in your circumstances because you have relied on the payment of money by the insolvent company. Lawpath’s expert Corporate Lawyers can assist you in defending the transaction. Receive a free quote here.
