Uncommercial Transactions in Insolvency Law
Teresa Dwight
Interpreting Legislation
The overarching intention that seeks to balance an encouragement of entrepreneurs in risk taking with protecting creditors from reckless directors as competing policies in insolvency law, places much of the legislation in perspective . The purpose of s588FB in Division 2 Part 5.7B of the Corporations Act is aimed at broadening the types of transactions that can be classed as voidable transactions, under s588FE and insolvent transactions, under s588FC. Pre-liquidation transactions provide for a means by which a liquidator can recover for unsecured creditors and are significant due the reluctance of courts and parliament to interfere with the activities of a Corporation (Lipton and Herzberg 2004:33). This ‘corporate veil’ is a result of the first policy requirement that seeks to encourage risk taking. Because it is lifted when a company becomes insolvent, insolvency provides the only opportunity whereby a court can scrutinize the companies’ activities (Lipton et al 2004:581). A broad scope for insolvent transactions is therefore required to protect the interests of creditors and investment, whilst preserving the balance of the two policies.
The basis for interpreting s588FB has always been on the purposive approach in s109H (now s15AA of the Acts Interpretation Act) cited in Demondrille and McDonald which gives reference to the 1992 Explanatory Memorandum, “a transaction of such magnitude that it could not be explained by normal commercial practice” (Warde 2003:2). Peter Pan concerned whether a transaction where more was paid for security than what it was worth, was an uncommercial transaction under s588FB. The court applied Demondrille and the purpose in the 1992 Explanatory Memorandum to conclude that it was not a transaction of this magnitude as it would not be unreasonable to expect a Corporation to act in this manner in these circumstances.
Insolvency
The requirements under s588FB that the liquidator must satisfy that the company must be insolvent at the time of the transaction or as a result of the transaction, arguably result in complications for the liquidator (Lipton et al 2004:581). The article argues that these complications place extra burden on the liquidator (Morrison et al 1999:188). This argument is supported by a subsequent case, Skouloudis which clarifies that the onus is on the liquidator to prove insolvency. The difficulties that arise in proving insolvency is inherent in the difficulties in clarifying its definition, as illustrated by the recent decision of Palmer J in Lewis & Anor v Doran & Ors where the phrase in s95A “from its own monies” was considered (Hibberd 2004:1). The court has the benefit of ‘retrospective’ hindsight and this reflects the extra duty on the liquidator (Hibberd 2004:2).
The article comments that the effect of the broad scope of uncommercial transactions is that a transaction could be a commercial transaction when the company is solvent but an uncommercial transaction when the company is insolvent (Morrison et al 1999:189). However, it is the very purpose of a pre-liquidation transaction under Division 2 Part 5.7B to enable a liquidator to access a greater net amount for an insolvent company’s creditors (Duns 2000:119). Arguably, therefore, there should be no issue with uncommercial transactions where a company is solvent because where a company is solvent, there is no one seeking to recover.
Valuation
The article notes the differences between the Harmer Report’s “undervalue” and the legislation’s “uncommercial” the differences of which can by explained by reference to the purpose of broadening the pre-liquidation transactions that can be made voidable and insolvent under s558FB (Lipton et al 2004:581). The article cites McDonald to explain that “uncommercial” was more appropriate than “value” because of possible “technical problems that could arise” with respect to defining value (Morrison et al 1999:191). Recent cases clarify that value becomes particularly relevant in proving “detriment” under s588FB(1)(b) or “benefit” under (1)(a) (AAR 2001:11). In Peter Pan, the difference between the price the company paid and the actual selling price was a significant $868, 000. The “detriment” to PPM in Peter Pan, was found not to be a “detriment” under the meaning of s588FB because there was no evidence that PPM could have found security at a lower price, or even at all . Similarly, in Skouloudis, the argued detriment was found to be no detriment at all because there was no evidence that the business sold by the company could have been sold for a higher amount.
Types of Transactions
Another point made by the article is that the broad scope of “uncommmerciality” means that a wide variety of transactions that can be caught by the provision. Mann v Sangria supports the argument that the meaning of “transaction” will be construed widely by the court (AAR 2001:2). The forgiveness of a debt in Lewis v Cook was held to be an uncommercial transaction due to subsequent detriments . In Sparks v Berry it was argued that the forgiveness of a debt was not an uncommercial transaction as it was not a “transaction” under section 9. It was held in this case and re-iterated in MacQuarie that legal requirements are not necessary to make a “transaction” . However, Brown v DML illustrates that liquidators should still be careful of defences in s588FG and natural justice (AAR 2001:17).
Unfair Preference
A major effect of uncommercial transactions is how it relates to unfair preference under s588FA, the other voidable transaction (Morrison et al 1999:194). The article, citing McDonald, raises the issue that it may be possible for an unfair preference to be an uncommercial transaction as a result. Morrison and Anderson (1999:194) agree that it doesn’t appear to follow that a transaction which is an unfair preference would necessarily also be an uncommercial transaction. The key difference between unfair preference and uncommercial transactions is that an unfair preference relates to a transaction where a creditor is the recipient whereas uncommercial transaction enables liquidators to make an application to recover from recipients who aren’t creditors, thus preventing companies from disposing their assets through ‘gifts’ . Furthermore, it is arguable that limiting the provision by confining the definition of “transaction”, would contravene part of the purpose of the section to prevent the giving of ‘gifts’ (De Jong 2003:201).
S588G(1A) makes an uncommercial transaction a debt for the purposes of s588G, ultimately expanding the duties of directors not to trade while insolvent . The article makes some suggestion that uncommerciality is becoming too broad with few limits of the foreseeable scope of the provision . However, Morrison (2002:238) concedes that recent case law has brought more certainty to the provisions. Furthermore, recent cases such as Sparks v Berry , where a director borrowed the company’s entire capital and had the debt waived, and Lewis v Cook where a company waived a substantial debt of a brother company , which illustrate the position of directors demonstrate behaviour which also constitutes a breach of equitable and fiduciary duties to creditors (Broderick and Lenicka 2004:12). In reference to creditors, Sutherland which ordered a repayment of “preferences” by creditors clarifies where there are responsibilities on creditors to be aware of insolvency (AAR 2001:14).
Conclusion
The purpose of the uncommercial transaction regime is to enable wider scope for liquidators to recover on behalf of creditors to balance the competing policy concerns that seek to both encourage entrepreneurial risk taking and at the same time protect creditors from reckless directors. The insolvent requirement for the provision, while appearing to be an added burden on the liquidator is a necessary requirement for the purpose. The term “uncommmerciality” is broad in order to give liquidators scope outside unfair preferences and beyond. However, the results of interpretation, particularly on directors, may lead to concerns that the provision has too much breadth which may lead towards discouraging directors to engage in risk taking. However, considering that recent case law has demonstrated the further scope for uncommmerciality and the options available for both creditors and directors in insolvency law, the law appears to remain balanced.
References
Allens Arthur Robinson, 2001. Annual Review of Insolvency & Restructuring Law 2001 - Uncommercial Transaction, Preference Payments and Disclaimer of Onerous Property Online: http://www.aar.com.au/pubs/arir/2001/uncommerical.htm Accessed: 9th January, 2005.
Allens Arthur Robinson, 2003. Annual Review of Insolvency & Restructuring Law 2003 - Uncommercial Transaction, Preference Payments and Disclaimer of Onerous Property Online: http://www.aar.com.au/pubs/arir/2001/uncommerical.htm Accessed: 9th January, 2005.
Broderick, Matthew., and Michael Lenicka. 2004. ‘Uncommercial Transactions – Corporate Governance for Insolvent Companies’, C&SLJ, 22(1):7.
De Jong., Leigh. 2003. ‘The Corporations Act Approach to Uncommercial Transactions – Is it Working?’, Insolvency Law Journal, 11(4):199.
Duns, John. 2000. ‘Uncommercial Transactions; Lewis v Cook’, Insolvency Law Joural, 8(2):110.
Hibberd, M, 2004, ‘The Definition of Insolvency,’ Newsletter, Cornwall Stodart Lawyers.
Lipton, Phillip., and Abe Herzberg., 2004. Understanding Company Law, 12th Edition, Lawbook Co., Sydney.
Morrison, David., and Colin Anderson., 1999. ‘Uncommercial Transactions – Developments in the New Regime’, Insolvency Law Journal, December 1999, 7(4):184.
Morrison, David. 2002. ‘The addition of uncommercial transactions to s588G and its implications for phoenix activities’, Insolvency Law Journal, December 2002, 10(4):229.
Morrison, David., 2002. ‘When is a Company Insolvent?’, Insolvency Law Journal, March 2002, 10(1):4.
Parliament of Australia, House of Representatives, 2000. Corporations Law Amendment (Employee Entitlements) Bill 2000 Explanatory Memorandum, Circulated with the authority of the Treasure, the Hon Peter Costello MP
Warde, J., 2002. “Paper: Uncommercial Transactions, 4th September 2002,” Allens Arthur Robinson Publications, Online: http://www.aar.com.au/pubs/insol/cirsep02.htm
Accessed: 6th January, 2005.
Cases referred to
Brown & Anor v DML Resources Pty Ltd (In Liq) & Anor (No.2) [2001] SCSR 219
Demondrille Nominees Pty Ltd v Shirlaw (1997) 25 ACSR 535
Lewis & Anor v Doran & Ors [2004] NSW SC608
Lewis v Cook [2000] NSWSC 191
Mann & Another v Sangria Pty Limited Unreported, Supreme Court of NSW, per Bryson J, 21 March, 2001
MacQaurie Health Corp Ltd v FCT (1999) 96 FCR 238
McDonald v Hanselmann (1998) 28 ACSR 49
Peter Pan Management Pty Limited (in liquidations) v Capital Finance Corporation (Australia) Pty Limited [2001] VSC 227
Sparks & Anor v Berry & Anor (2001) 19 ACLC 1430
Skouloudis Group Pty Ltd (in Liq) v Planet Enterprizes Pty Ltd [2002] NSWSC 329
Sutherland (in his capacity as Liquidator of Sydney Appliances Pty Ltd (In Liquidation)) v Eurolinx Pty Ltd Unreported, Supreme Court of New South Wales per Santow J, 30th March, 2001
copyright, 2004