Chapter 2 - The Bill in the context of current insolvency law
Background
2.1
The origin of this Bill lies in the collapse of the telecommunications carrier One.Tel in
May 2001. Shortly after One.Tel was placed into administration it was reported
that the company’s co-managing directors, Mr Keeling and Mr Rich, had each received approximately $7 million in bonuses from the
company in a year in which it had incurred substantial losses. In response to
public concerns about the circumstances surrounding the collapse of One.Tel and
the payment of bonuses to its directors, the Prime Minister announced on 4 June 2001 that:
The Commonwealth intends to amend the law so that in future,
where bonuses are paid in the circumstances where those bonuses were paid to
the bosses of One.Tel, that money will be refundable and can be used to meet
the lawful and legitimate entitlements of workers and also the other creditors
of the company. [1]
2.2
Other inquiries have brought to light
inappropriate transactions between companies and their directors.[2]
2.3
The Bill permits liquidators to reclaim unreasonable payments made to
directors of companies that are subsequently put into liquidation.
Voidable transactions
2.4
Insolvency law has long adopted a policy of
setting aside transactions in which an insolvent company disposes of property
or makes payments to particular creditors within a relevant period of time
prior to the commencement of formal insolvency. A debtor may be placed into
external administration months or sometimes years after recognizing that this
outcome is inevitable. In anticipation of the formal commencement of insolvency
proceedings debtors may attempt to hide assets from their creditors, favour
certain creditors over others, incur artificial liabilities or make gifts to
relatives or friends. Outside an insolvency context some of these transactions
may be perfectly permissible. In an insolvency context they may be unfair to
the general body of unsecured creditors. The purpose of these laws is to
prevent the depletion of the assets of the company through certain transactions
entered into within a specified period prior to the winding up.
2.5
Under the Corporations Act liquidators may
recover certain payments made, or reverse certain transactions entered into, by
companies in the period preceding the company’s liquidation. Division 2 of
Part 5.7B deals with those company transactions and payments which may be
challenged by a liquidator during the period preceding formal insolvency.
2.6
The provisions, known as the ‘clawback’ or
voidable transaction provisions, permit liquidators to seek court orders
reversing certain transactions entered into by an insolvent company in the
lead-up to liquidation or, in limited circumstances, in the period prior to the
company becoming insolvent. There are essentially four types of transactions
which are able to be challenged under the avoidance provisions: unfair
preferences, uncommercial transactions, unfair loans and fraudulent
transactions.
2.7
The key operative provision is section 588FE
which provides that certain pre-liquidation transactions are to be regarded as
voidable transactions. Under section 588FE two types of transactions are
voidable: insolvent transactions (defined in section 588FC) and unfair loans
(defined in section 588FD).
Insolvent transactions
2.8
An insolvent transaction must be either an
unfair preference (defined in section 588FA) or an uncommercial transaction
(defined in section 588FB). To constitute an insolvent transaction, the
company which is in liquidation must either have been insolvent when the
transaction was entered into or become insolvent as a result of entering into
the transaction. A transaction is not voidable solely because it is an
‘insolvent transaction’. Under section 588FE(2)–(5) an insolvent transaction
is voidable where, in addition, it is:
- entered into during the six months immediately before the
relation-back day (in most cases the day when the application to wind up
the company was filed with the Court);
- an uncommercial transaction entered into during the two years immediately
before the relation-back day;
- an unfair preference and an uncommercial transaction involving a
related entity of the company and occurring during the four years immediately
before the relation-back day;
- an unfair preference and an uncommercial transaction entered into
during the four years immediately before the relation-back day where the
company was a party to the transaction in order to defeat, delay or interfere
with the rights of any or all of its creditors (section 588FE(5)).
Unfair loans
2.9
Most payments made by a company prior to a
winding up are not generally recoverable by a liquidator unless the company was
insolvent at the time it made the payment (or became insolvent as a result of
making the payment). However, unfair loans are voidable irrespective of
whether the company was insolvent at the time it made the loan. An ‘unfair
loan’ is defined in section 588FD as one where the interest was ‘extortionate’
at the time when the loan was made or has since become extortionate because of a
variation. The explanatory memorandum to the 1992 Corporate Law Reform Act
(para 1048) noted in relation to this provision:
The section is not directed to loans which in hindsight may be
judged as bad bargains but at transactions which are grossly unfair, so that in
normal circumstances no reasonable company is likely to have entered into such
a contract unless there were some further rationale such as where the agreement
is a sham agreement intended to operate in circumstances of insolvency to
confer an undue benefit on the lender.
2.10
The following table summarises the transactions
that are voidable under the current law and the time frame in which they are
voidable.
|
Type of transaction
|
Length of time prior to relation-back day |
Section
|
|
Insolvent transaction
(with a non-related entity)
|
6 months
(or after the relation-back
day but on or before the day when the winding up began) |
588FE(2)
|
|
Insolvent and
uncommercial transaction (with non-related entity)
|
2 years |
588FE(3)
|
|
Insolvent transaction
to which a related entity of the company is a party
|
4 years |
588FE(4)
|
|
Insolvent transaction
entered into for the purpose of defeating, delaying or interfering with the
rights of any or all of the creditors
|
10 years |
588FE(5)
|
|
Unfair loan
|
No time limit |
588FE(6)
|
Unreasonable director-related
transactions
2.11
The Bill adds the category ‘unreasonable director-related transaction’ to
the list of voidable transactions in section 588FE. The main focus of the bill
is on transactions entered into by the company with its directors but extends
to transactions made to, on behalf of, or for the benefit of a director or a
close associate of a director.
2.12
Under proposed section 588FDA(1) an
‘unreasonable director-related transaction’ includes payments made by the
company, conveyances, transfers and other dispositions of property and issues
of securities including options. Incurring an obligation to enter into these
kinds of transfers would also be a ‘transaction’ for the purposes of the Bill.
2.13
The Bill targets ‘transactions’ that a reasonable person in the company’s
circumstances would not have entered into. Under proposed section 588FDA(2) a
transaction will be caught if it may be expected that a reasonable person in
the company’s circumstances would not have entered into the transaction having regard
to the benefits and detriments to the company of entering into the transaction,
the benefits to other parties to the transaction and any other relevant
matter.
2.14
The reasonableness of the transaction is
determined at the time the payment, transfer or disposition of property, etc
occurs and not at the time the company incurred the obligation. A liquidator
will be able to recover payments where the unreasonableness of the transaction
becomes apparent when the company actually makes the payment even if it
appeared reasonable at the time the company incurred the obligation. Where a
payment is made to a director or a close associate of a director a court will generally
not be required to determine the reasonableness or fairness or otherwise of the
obligation incurred by the company when the bargain was struck.
2.15
Under proposed section 588FE(6A) an unreasonable
director-related transaction will be voidable where it is entered into or given
effect to within four years of the relation-back day.
2.16
Unreasonable director-related transactions will
be voidable irrespective of whether the company was insolvent at the time of the
payment, transfer or disposition of property occurs or at the time the company
incurred the obligation.
2.17
Proposed subsection 588FF(4) restricts the range
of orders that a court may make in relation to voidable transactions. The
court may make orders only in relation to the unreasonable portion of the total
transaction taking into account the reasonable value (if any) that is
attributable to it.
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