In circumstances where a single unsecured creditor of a company in liquidation has received a considerable benefit over and above that received by the other unsecured creditors just prior to the company’s liquidation, one could be excused for thinking this would give rise to a classic uncommercial transaction claim under section 588FB of the Corporations Act 2001 (Cth.).

In this context, the recent Victorian Supreme Court decision of 640 Elizabeth Street Pty Ltd (in liq) & Ors v Maxcon Pty Ltd [2015] VSC 22 (640 Elizabeth Street) demonstrates the equally classic adage that one should never make assumptions!

The decision makes it clear that, where a transaction is ‘otherwise commercial and entirely appropriate’ it will not become an uncommercial transaction simply because other creditors are not treated equally. The Court found that it is necessary to balance the commercial benefits and detriments to each party, rather than focusing on a purely technical analysis of the parties’ legal rights and obligations.

The facts in 640 Elizabeth Street were as follows. 640 Elizabeth Street Pty Ltd (640) sought to develop property it owned into residential units. To that end, 640 entered a joint venture agreement with Jabbour 640 Pty Ltd (Jabbour), and a special purpose vehicle, Elan Apartments Pty Ltd (Elan), was appointed as the development manager/nominee.

Elan subsequently entered into a building contract with Maxcon Pty Ltd (Maxcon) for the construction of 54 residential units. The joint venture agreement entitled Elan to be indemnified by Jabbour and 640 for any liabilities it incurred as the development manager, including its liability to the builder, Maxcon. Elan’s indemnity also extended to payment out of the gross sale receipt of the units.

Following practical completion, Maxcon demanded payment of a debt owed to it by Elan, for which it was unsecured. In order to prevent Maxcon from suing Elan for recovery of the debt, 640 provided security to Maxcon by charging the remainder of the units it owned in the development to secure the payment that Maxcon had demanded.

Subsequently, liquidators were appointed to 640, and sought to set aside the transaction between Maxcon and 640. The liquidators argued that it was an uncommercial transaction pursuant to s 588FB of the Corporations Act 2001 (Cth).

The trial judge refused to set aside the transaction and the liquidators appealed to the Court of Appeal.

The liquidators submitted that 640 had suffered detriment by incurring a liability to pay Elan’s debt and encumbering 640’s property, without receiving any corresponding benefit and without 640 being under any legal compulsion to do so. As a consequence, they submitted that a reasonable person would not have entered into the transaction and the transaction was therefore uncommercial within the meaning of 588FB of the Act.

In dismissing the liquidators’ appeal, the court held that no detriment was suffered by 640. Under the joint venture deed, Elan had a right of indemnity against 640 and Jabbour and a right to be indemnified out of the gross sales of the units. The result of the transaction was effectively to replace 640’s liability to Elan with an equal liability to Maxcon.

His Honour Sifris J agreed with the trial judge that a real benefit was conferred on 640 by entering into the transaction, as it had the effect of avoiding the costs of the litigation which had been threatened against Elan by Maxcon.  640 would have been liable for those costs pursuant to the indemnity.

Despite the liquidators’ submission that Maxcon had benefited from receiving security for the debt without suffering any detriment, the Court found that that there was actually no disproportionate benefit to Maxcon as it was highly likely that, in any event, Maxcon would have been paid by Elan.

His Honour Sifris J ultimately found that the transaction between 640 and Maxcon was not uncommercial. Rather, it was ‘perfectly explicable and…readily and easily…explained by normal commercial practice’.  Accordingly, the liquidators’ appeal was dismissed.

The case serves as a reminder that there is more to establishing that a company in liquidation has entered into an uncommercial transaction than identifying that a single creditor has received a disproportionate benefit over and above the others from a debtor which was under no legal compulsion to give that benefit. The surrounding circumstances, the relationships between all parties involved in or affected by the transaction and whether the transaction could be said to be ‘easily explicable as normal commercial practice’ will all need to be considered before a proceeding to set the transaction aside should be commenced.

If these additional matters are ignored, liquidators may find themselves on the wrong side of a very large costs order from both the Supreme Court and the Court of Appeal, as was almost certainly the case in this matter.