Stopping the Phoenix From Rising: Australian Court Provides First Guidance on Creditor-Defeating Dispositions
In Short
The Situation: In February 2020, amendments to the Corporations Act 2001 (Cth) expanded the kinds of transactions that may be voidable if a company is being wound up to include asset disposals undertaken as part of illegal phoenixing schemes. Such disposals are termed as "creditor-defeating dispositions" in the legislation.
The Development: The recent decision of the Supreme Court of Victoria in Re Intellicomms Pty Ltd (in liq) [2022] VSC 228 is the first time a court has applied the creditor-defeating disposition provisions. The Court found a sale agreement for assets of Intellicomms made immediately before it was placed into voluntary liquidation to be a phoenixing activity in breach of the new creditor-defeating disposition provisions. The Court declared the sale agreement void and has asked the parties to provide proposed orders for unwinding the transactions.
Looking Ahead: The decision provides the first court guidance regarding the application of the creditor-defeating disposition provisions. The clarification around a liquidator's rights to set aside improper transactions prior to a company's insolvency is relevant not just for liquidators but also companies who may be experiencing financial difficulties, their creditors and potential purchasers of assets. Care should be taken in any distressed restructuring exercise to ensure that asset sales do not fall foul of the new creditor-defeating disposition provisions.
Background
In February 2020, the Corporations Act 2001 (Cth) ("Act") was amended to add a new class of voidable transactions for companies that are being would up known as "creditor-defeating dispositions". This change was directed to extend the reach of the court's powers by allowing it to declare phoenixing activity as a creditor-defeating disposition and then void the transaction.
Creditor-Defeating Dispositions
Under s 588FDB, a creditor-defeating disposition is the disposition of company property for less than the market value of the property, or the best price reasonably obtainable for the property having regard to the circumstances existing at the time (whichever is the lesser) that has the effect of preventing that property from becoming available for the benefit of the company's creditors, or hindering or significantly delaying the process of making it available for the benefit of the company's creditors, in the winding up of the company.
A creditor-defeating disposition will be voidable by a court if it is made by a company at a time when it is insolvent, it becomes immediately insolvent because of the transaction or it enters external administration within 12 months of the transaction. The test is applied as of the time the relevant agreement for the disposition is entered into or—if there is no agreement for the disposition—as of the time of the disposition.
There are a number of carve-outs that protect legitimate acts taken by a distressed company, including acts taken by administrators, restructuring practitioners and liquidators.
Background to Re Intellicomms Pty Ltd (in liq) [2022] VSC 228
Intellicomms Pty Ltd ("Company") operated a business providing translation services to commercial enterprises.
On 8 September 2021, the Company executed a sale agreement with Tecnologie Fluenti Pty Ltd ("TF"), pursuant to which TF purchased the assets relied on by the Company to operate the business for approximately AU$22,000 (after agreed adjustments) ("Sale Agreement"). TF had been incorporated two weeks prior, and its sole director and shareholder was an employee of the Company and closely related to its sole director.
As part of the Sale Agreement, TF assumed the Company's liabilities for transferring employees' accrued entitlements (with adjustments to the purchase price to reflect the extent of those liabilities), but otherwise the Company was left with approximately AU$3.2m in other liabilities. Later that same day, the Company was placed into a creditors' voluntary winding up, and the liquidators were appointed for the Company.
From a timing perspective, the Sale Agreement was entered into in circumstances where the director was aware that a statutory demand for an apparently undisputed debt of approximately AU$923,310 had been issued, and was due to expire on the date of the Sale Agreement. If the period had expired without the Sale Agreement being entered into, the creditor who issued the demand would have standing to file an application for an order to wind up the Company in insolvency and distribute the assets at full value to all of creditors through the insolvency process.
On 4 October 2021, the Company's liquidators commenced proceedings against TF. By their originating application, they sought orders that the Sale Agreement be set aside as a creditor-defeating disposition (or alternatively, an uncommercial or unreasonable director-related transaction under s 588FB and 588FDA respectively, although these claims were not pressed at the hearing) and that the assets be returned to the liquidators. To unwind the Sale Agreement and return the assets to the Company, they sought ancillary orders to effectively assign and novate any contracts between TF and former customers of the Company back to the Company (provided the customers consented) or otherwise to void the contracts.
TF conceded that the Sale Agreement prevented the Company's assets from becoming available for the benefit of its creditors in its winding up and that it was insolvent at the time it entered into the agreement. TF's defence was that the consideration payable under the Sale Agreement was not less than the market value or the best price reasonably obtainable for the assets in the circumstances.
TF relied on expert evidence as to the market value of the assets. That expert evidence did not provide an opinion as to the best price reasonably obtainable for the assets, save as to say that such price would not exceed the market value.
The liquidators did not undertake their own valuation of the assets and instead relied on:
- The background to the transaction, which included a series of four valuations commissioned by the Company, each with a progressively pessimistic outlook for the Company;
- An expert report criticising the valuation reports relied on by the Company; and
- Evidence from the liquidators that several other entities in the industry, including the creditor who issued the statutory demand ("QPC"), may have been interested in participating in a competitive sales process for the purchase of the relevant assets.
TF submitted that in the absence of evidence as to the actual market value of the assets and the best price reasonably obtainable for the assets in the circumstances, the Court could not make a finding that the consideration paid under the Sale Agreement was less than both of these amounts.
Decision of the Court
The Court rejected TF's submission. Rather, the Court found that all that was required of the liquidators was to establish on the balance of probabilities that the consideration payable under the Sale Agreement was less than both the market value and the best price reasonably obtainable, having regard to the circumstances at the time of the Sale Agreement, including the expiration of the creditor's statutory demand.
The Court accepted the liquidators' criticisms of the Company's valuation evidence and found on the balance of probabilities that the market value of the assets was significantly more than the valuation. The Court also found that despite the market value of the assets never being tested, it was clear that they had a unique value to QPC (noting it was funding the liquidators at considerable cost), and it would have been prepared to pay considerably more for the assets than the consideration paid under the Sale Agreement.
In addition, the Court held that the Sale Agreement was entered into at a time when Intellicomms was insolvent.
The Court indicated that it would make orders declaring the Sale Agreement void.
Three Key Takeaways
- The creditor-defeating disposition provisions provide another avenue—in addition to the other categories of voidable transactions—for liquidators to claw back the assets of a company. There is overlap between the creditor-defeating disposition and uncommercial transaction provisions. In many cases, it is likely a transaction could be voided under either or both categories, but the creditor-defeating disposition provisions provide a fit-for-purpose provision that does not rest on whether a reasonable person, having reference to the benefit or detriments to the company, would have entered into a transaction.
- To establish that a transaction amounts to a creditor-defeating disposition within the meaning of s 588FDB of the Corporations Act 2001 (Cth), it is necessary to establish that on the balance of probabilities, the consideration received for the disposition was less than both the market value and the best price reasonably obtainable for the assets in the circumstances. However, it is not necessary to establish what those actual amounts in fact were. The surrounding circumstances of a particular transaction will vary from case to case, but courts may look to facts such as the relationship between the persons standing behind the company and the purchaser, the steps taken to ascertain prospective purchasers for the assets and test the market value of the assets, and the proximity between the disposition and the company's winding up.
- Courts can order that a creditor-defeating disposition is void and that the property be returned to the liquidators, even if it would impact third parties.
