Ashurst Restructuring Roundup

Lenders Beware: Security Vulnerable as an unreasonable director-related transaction

Cooper as Liquidator of Runtong Investment and Development Pty Limited) v CEG Director Securities Pty Limited [2024] FCA 6. ("CEG")

The benefit obtained by the directors from an unreasonable director-related transaction may be direct or indirect and the circumstances of the company (in terms of benefit, detriment and other considerations affecting the transaction) are assessed at the time at which it is undertaken. Significantly, it is not necessary to prove either that the company was insolvent at the time of the transaction or that its counterparty was on notice that it benefited the director.

In CEG, a financier (CEG) lent funds to two companies (Datong and Futong) to develop land. Some of the directors of Datong and Futong were also directors of a third company, Runtong ("Company"). Those directors had given personal guarantees to CEG on account of the borrowings of Datong and Futong. They caused the Company to mortgage land which it owned to CEG as security for the loans which it had made to Datong and Futong. At the time of that transaction the Company had not borrowed any money from CEG nor had it requested it to lend money to Datong and Futong.

An application was made to avoid the mortgage as an unreasonable director – related transaction.

That application raised at least these issues:

(a) was the mortgage a disposition by the Company of its property;

(b) if so, did that disposition confer a benefit on the Company's directors?; and

(c) may it be expected that a reasonable person in the Company's circumstances would not have granted the mortgage?

Some preliminary matters might be noted:

(a) it is not necessary to prove that a company was insolvent at the time of undertaking an alleged unreasonable director – related transaction;

(b) the assessment of the transaction (from the perspective of the company) is made at the time at which it was undertaken and not by reference to subsequent dealings between the company and the counterparty to the transaction; and

(c) for relief to be granted in respect of such a transaction it is not necessary to establish that the counterparty had any knowledge which put it upon inquiry as to whether the transaction was an unreasonable director – related transaction?

Was the mortgage a transaction?

It involved a disposition of the Company's property and, as such, was a transaction.

Did the grant of the mortgage confer a benefit on the Company's directors?

The Court (at [27]) followed an earlier decision to the effect that the phrase "for the benefit of " meant; "'both direct and indirect benefits'", and that "the natural and ordinary meaning of a requirement that something be for 'for the benefit of' a person is that it be 'for the advantage, profit or good' of the person and that the focus of the sub-section was to capture any benefit which legally or financially advantages the director in question."

The Court held that the fact that CEG benefited from the mortgage granted to it did not mean that the directors did not also benefit. Therefore, the Court rejected a contention that the granting of the mortgage to CEG did not confer a benefit to CEG for the benefit of the directors. Any reduction in the directors' personal liability under the guarantees they had given resulting from the realisation of the mortgage granted by the Company was to the benefit of the directors in that it conferred an indirect benefit and advantage on the directors financially.

May it be expected that a reasonable person in the Company's circumstances would not have given the mortgage?

At the time the mortgage was granted the Company was not a borrower from CEG and had not requested CEG to make any loans. In the circumstances, it was not possible to identify the benefit which it derived from granting the mortgage. Conversely, it suffered a significant detriment by becoming liable for debts in respect of which it had no previous obligation. Whilst there were loans which CEG made to the Company after the grant of the mortgage that was not a relevant consideration when it came to determining whether a reasonable person circumstances of the Company would have undertaken the transaction. That assessment has to be made by reference to the circumstance of the Company at the time at which the transactions was undertaken.

It might be noted that, whilst the Company was a related entity to Datong and Futong, they were not related bodies corporate and, therefore, not part of a "corporate group". If that had been the case, it may have been sufficient to satisfy the Court that the Company had derived a benefit from the grant of the mortgage.

Compensation under s588FF, Corporations Act

The Court did not find a need to declare the security void as the mortgaged property had already been sold by CEG as mortgagee.

Instead, the Court looked to awarding compensation. The compensation was determined, in essence, by reference to the benefit which CEG derived from the proceeds it realised from the sale of the mortgaged property and the advances subsequently made by CEG for the benefit of the Company. This was the Court's approach even though the fact that those advances by CEG were for the benefit of the Company was not a relevant consideration when it came to determining whether or not a reasonable person in the position of the Company would have undertaken the transaction by reference to the company's circumstances at the time the mortgage was granted.

Author: Richard Fisher, AM