Lately a liquidator lost costly litigation in the Court of Appeal in relation to suspected director-related transactions. It is worth considering what occurred in this case so that you can avoid history repeating.

The decision in Crowe-Maxwell v Frost concerned an attempted recovery under s588FDA of the Corporations Act 2001 (Cth) (Act).  The liquidator was the first appellant and had challenged the dismissal of the proceedings in the District Court.

The facts

The respondents were the sole shareholders and directors of a childcare business (Business) which was operated through the second appellant corporation (Company).  The Business was conducted from the residential premises of the respondents.

In the final years of the operation of the Business, the respondents failed to keep their personal expenses separate from the expenses of the Company and failed to keep proper books of account for the Company.

The first respondent worked full-time for the Business and the second respondent worked for the Business from time to time. There were no records of either respondent being paid wages, although the Company paid various personal expenses.

The Business began to suffer by way of falling child enrollments from about 2005, which impacted upon the financial viability of the Company. As a result, the first respondent contended that he had used personal savings, as well as borrowings from his family, to continue to operate the Business.

On 19 November 2008, an application was made by the Workers Compensation Nominal Insurer for the Company to be wound up and the first appellant was appointed as liquidator of the Company. The relation-back period for the purposes of any recoveries commenced on 19 November 2008.

The appellants’ claim

The appellants sought to recover money alleged to have been paid by the Company for the directors’ benefit, on the basis that the payments were unreasonable director-related transactions within the meaning of  s588FDA of the Act.  If this argument was successful, the transactions would be considered voidable transactions and the liquidator could have obtained orders for the return of the amounts the subject of the transactions.

The appellants alternatively sought recovery of the money on the basis of equitable compensation for breach of directors’ duties.

The exact amounts of the payments remained in issue and were alleged by the appellants to be:

1. Personal expenditures: $143,639.97;
2. Payment to bank account in the name I & K Frost: $2,200.00
3. Personal loan repayments: $51,500.00; and
4. Payment to Mr A Frost: $8,900.00

The appellants accepted that a deduction of $69,531.00 was to be made, to account for payments made into the Company bank account of the second respondent’s wages from her employment which was unrelated to the Company. The balance claimed by the appellants was $136,508.97.

In the decision at first instance, P Taylor SC DCJ dismissed the appellants’ claim and held that the appellants were not entitled to recover these monies on the grounds that:

1. The case did not involve an expropriation of the Company property;
2. The liquidator failed to demonstrate insolvency of the Company at any time; and
3. The amounts paid to the respondents did not exceed what was reasonable for the Company to pay the respondents for their labours.

Appeal by the Appellants

The appellants lodged an appeal, arguing that:

1. The trial judge incorrectly took into account, as evidence, the defence filed by the respondents as “pleadings could not be evidence”;
2. The trial judge incorrectly relied upon statements made by the first respondent from the bar table as evidence of the matters stated.
3. It was insufficient to discharge the first appellants’ onus of proving that the relevant transactions were unreasonable director-related transactions by pointing to the fact that payments for personal expenditure had been made and there was an absence of Company resolutions or accounting records relating to those payments.
4. Having discharged that onus, the respondents bore the onus of proving that those payments provided some benefit to the Company.

Findings of the New South Wales Court of Appeal

In dismissing the appeal, Beazley P with Macfarlan and Gleeson JJA in agreement, aligned with the lower court decision, holding that:

1. Statements made in verified pleadings may constitute admissible evidence and the trial judge did not err in ruling that parts of the defence were admissible.
2. Statements made at the bar table are not evidence. The trial judge did not err on relying upon statements from the bar table. It is not unusual or impermissible for the Court to take into account explanatory statements and characterisations of evidence proffered from the bar table.
3. The onus of establishing that a transaction constitutes an unreasonable director-related transaction rests with the party making the allegation. In circumstances where there is limited evidence of the nature or purpose of a transaction, the courts may infer the transaction was unreasonable especially in circumstances where the surrounding circumstances show it to be a departure from normal commercial practice of the Company (without a commercial explanation). In this case, the first appellant had failed to discharge his onus of proof as there was no evidence upon which to base that inference.
4. Impropriety or breach of director’s duty is not required in order to establish an unreasonable director-related transaction.
5. The inquiry under section s588FDA(1)(c) of the Act is concerned with the reasonableness of the Company’s conduct, objectively assessed by reference to the circumstances of the Company.
6. When conducting the evaluative inquiry under s588FDA(1)(c) of the Act, normal commercial practice and prior contractual relationships is a relevant but not determinative of the matter.
7. A transaction of derivative benefit can still be for the benefit of the Company.

Importance of Case

This case highlights the importance of liquidators leading evidence to discharge their onus of proof and provides a summary of the relevant principles for liquidators to consider when seeking to recover payments which are alleged to constitute unreasonable director-related transactions under s588FDA of the Act.

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