WHAT YOU NEED TO KNOW

Often referred to as “clawback provisions”, sections 588FA and 588FB of the Corporations Act 2001 (Cth) (Act) permit liquidators to recover certain transactions made by the insolvent company within a specified period prior to the commencement of the liquidation.

The provisions are designed to avoid unfair advantages to unsecured creditors over the pool of creditors. These transactions are known as “voidable transactions”, the most common of which are unfair preferences.
It is useful to understand the different categories of voidable transactions, the liquidator’s powers and the possibility of available defences.

When is a transaction voidable?

Section 9 of the Act defines a transaction as (without limitation )including a payment by the company, an obligation incurred, a company loan, a charge created on company property, a waiver or release, transfer of property or a guarantee.
For a transaction to be voidable within the meaning of s 588FE of the Act, it must be an insolvent transaction and to have occurred within the 6 month period prior to the liquidation or bankruptcy.
Types of voidable transactions include unfair preferences, uncommercial transactions, unfair loans and unreasonable director-related transactions. To know what to look out for when considering the question of solvency, please see our insolvency checklist.

Section 588FA: unfair preferences

Unfair preferences are the most common types of transactions pursued by liquidators (s 588FA). In order to establish a
preferential payment, the liquidator must establish that:

  • the transaction was between the company and a creditor
  • the company was insolvent at the time of the transaction
  • the transaction was entered into within the relation back period
  • the transaction resulted in the creditor receiving more than they would have, had the transaction been set aside and the creditor prove for the debt in the winding up (ie, they were preferred)

It is important to demonstrate that the creditor knew or should have suspected that the company was insolvent at the time the transaction was entered into.
The transaction must have occurred within the following dates prior to the relation backdate (the commencement of the winding up):

  • 6 months for transactions with unrelated parties
  • 4 years for transactions with related entities
  • 10 years where the purpose of the transaction was to defeat, delay or interfere with the rights of creditors.

Section 588FB: uncommercial transactions

Where a Court considers that the company gained no benefit or advantage from the transaction or it caused detriment to the company that cannot be explained by normal commercial practices, the Court may declare that it was an uncommercial transaction (s 588FB).
In order for the court to void the transaction, the following criteria must apply:

  • the company was a party to the transaction
  • it was an insolvent transaction
  • a reasonable person in the position of the company would not have entered into the transaction.

To be voidable, an uncommercial transaction must have occurred during the 2 years prior to the liquidation. If a related entity is a party to the transaction, however, the time period is 4 years and if the intention of the transaction is to defeat creditors, the time period is 10 years.
Professor Keay (Liquidators’ Avoidance of Uncommercial Transactions (1996) 70 ALJ 390 at 398) considers that transactions which may be challenged successfully include those where the company leases an asset over its rental value, forgives a debt, sells a business for less than market value, agrees to perform tasks for no consideration, makes gifts or provides security for a previously unsecured loan, to name a few.

Section 588FD: unfair loans

In circumstances where a lender provides a loan to the company which later goes into liquidation and the interest or charges on that loan are extortionate, the loan is voidable against a liquidator under s 588FD.
There are no timeframes imposed by the Act for recovery of unfair loans, and there are no statutory defences available to the lender in the event the loan is established to be an unfair loan.

Section 588FDA: unreasonable director-related transactions

Pursuant to Section 588FDA of the Act, a transaction is an unreasonable director-related transaction of a company if:

  • The transaction is a payment, transfer of property, issue of securities or incurring of an obligation by the company;
  • Made to the director or close associate of the director; and
  • A reasonable person in the company’s circumstances would not have entered into the transaction having regard to the benefit or detriment to the company or other parties.

Examples of unreasonable director-related transactions commonly encountered in practice include reductions in related
party loans, excessive or unreasonable remuneration/wages paid to directors.
The timeframe prescribed by the Act for such transactions is four (4) years from the commencement of the winding up.

Section 588FG: defences

A range of defences exist under the legislation for parties to a transaction, including that:

  • they became a party to the transaction in good faith;
  • they had no reasonable grounds for suspecting the company was insolvent or would become insolvent, at the time they entered into the transaction;
  • a reasonable person in those circumstances would not so suspect; and
  • they provided valuable consideration for, or changed their position in reliance on, the transaction.

The onus of proving the defence rests with the person claiming the defence (Levi v Guerlini (1997) 24 ACSR 159; 15 ACLC 913) and an actual apprehension or mistrust will suffice to prove “suspicion” of insolvency (see Wily (as joint liquidators of Boutique Resorts Management Pty Ltd) v Commissioner of Taxation [2002] NSWSC 909.

Section 588FF: Court powers to set aside transactions

The Court can make orders about voidable transactions on application by the company’s liquidator (s 588FF), including the following:

  • an order that a person transfers property to the company,
  • an order that a person pay to the company (liquidator) the amount received by that person under the transaction,
  • discharge a debt incurred by the company in connection with the transaction, vary an agreement or declare it void or
    unenforceable
  • an order that a person pays an amount which equates to some benefit the person may have obtained as a result of the transaction.

For more information on corporate insolvency review the resources below or contact us today.

CORPORATE INSOLVENCY KNOWLEDGE & ARTICLES

DEBT RECOVERY
If a creditor is owed money by a company, there are many ways they can seek to recover it. Directors and companies should be aware of their rights and obligations in the event that debt collection processes are in full swing and the company is exposed to legal action and enforcement.

CREDITORS
Taking an interest in the liquidation of a company that owes you money may help you to secure a better financial return. Whether you’re an employee who is owed wages or a supplier seeking payment, here is an overview of the rights and obligations of creditors in insolvency.

CREDITORS’ MEETINGS
When a company goes into liquidation, the Liquidator will use a Creditors’ Meeting to communicate with the creditors about the progress of the liquidation and to seek approval or guidance from creditors. In the case of Creditors Voluntary Liquidation a creditors’ meeting is required to be convened within 11 days of the appointment of a liquidator.

DIRECTOR PENALTY NOTICE
One of the most powerful tools wielded by the Australian Taxation Office is the ability to issue a Director Penalty Notice (DPN) against company directors for certain company debts including PAYGW and SGC. Serious implications flow from non-compliance with the ATO’s requirements it pays to be informed, upfront, lodge company statements on time and to maintain good order in the books.

EMPLOYEE ENTITLEMENTS SAFETY NET
When a Director is contemplating putting their company into liquidation, one of their biggest fears is that their loyal and hardworking staff won’t be paid their entitlements. Fortunately there is a government safety net that protects employee entitlements in these situations.

INSOLVENT TRADING
Insolvent trading occurs when a company is unable to pay its debts and continues to incur further debt. When a company is experiencing a cash flow or liquidity crisis, it is important that its directors and officers consider the company’s ability to pay all of its debts as and when they become due.

CORPORATE INSOLVENCY: AN OVERVIEW
A formal insolvency commences when a company is unable to pay its debts, prompting the appointment of an external administrator. Understanding the overall insolvency framework can assist you to lessen any financial and emotional impact as you move through the complex insolvency processes. The three most common types of formal insolvency appointments are Voluntary Administration, Liquidation and Receivership.

CORPORATE TURNAROUND
Get a broad overview of the major steps in turnaround strategy. One of the major drivers for business insolvency is failure to challenge business models and take strategic action early. When businesses started to find themselves in a tight financial position it is vital that an appropriate turnaround strategy is implemented quickly.

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