An unreasonable director-related transaction under section 588FDA of the Corporations Act

An unreasonable director-related transaction under section 588FDA of the Corporations Act

Slaven v Menegazzo [2009] ACTSC 94, Supreme Court of the Australian Capital Territory, Mansfield J, 14 August 2009

(a) Summary

In this case Michael Edward Slaven (the Liquidator), liquidator for R & R Nominees Pty Ltd (the Company), sought a declaration that a sale of land contract made on 4 August 2006 (the Contract) between the vendor Company and the purchaser Clinton Menegazzo (Menegazzo) was void.

The Liquidator made an application under section 588FF of the Corporations Act 2001 (Cth) (the Act) seeking to have the Contract declared void, on the basis that the Contract was an unreasonable director-related transaction for the purposes of section 588FDA of the Act.

The court declared that the Contract was void on the basis that it was an unreasonable director-related transaction as it would be expected that a reasonable person in the Company’s circumstances would not have entered into the transaction.

(b) Facts  

John Menegazzo and Raymond Schofield were the shareholders and directors of the Company. The Company sold the property to Menegazzo (John’s son) for $425,000, but the Contract contained unusual terms as to payment of the purchase price. The purchase price of $425,000 was to be satisfied by the payment of $40,000 to John Menegazzo (paid in cash on 4 August 2006) and by the release of his parents’ indebtedness to him of $130,000. No deposit was payable. The $40,000 was supposed to be paid at settlement but Menegazzo paid it when the Contract was signed, as his father indicated he otherwise would not sign the Contract.

John Menegazzo signed the Contract as a director of the Company, not in his personal capacity. The completion date was “21 days after notice of registration of Strata Plan”, which occurred only on 17 July 2007.  Completion never occurred.

The Company was a trustee company for the R & J Development Trust, of which the director’s family trusts were beneficiaries. At the time of the Contract, the Company was in the process of completing the construction of a development comprising ten units, with a projected net profit of $971,903.00.  This amount would be available for distribution to the unit holders.

The distribution from the sale of the development was anticipated to be $458,951.50 each to the Schofield interests and the Menegazzo interests. However, the property was sold on the understanding between the directors, not formally recorded, that the price would be deducted from the Menegazzo interests’ share of profit from the development.

Menegazzo took possession of the property soon after construction was completed, and added tiling, carpeting and blinds at a total cost of $5,398.  The Company was not required to install such fixtures, but Menegazzo was not obliged to install them either. The property was also used briefly as a display unit and rented for a few weeks during the holiday season, with the rent received given to John Menegazzo. Otherwise, since November 2006, Menegazzo generally occupied the property and exclusively occupied it since July 2008. He did not paid rent.  In February 2007 Menegazzo paid stamp duty of $14,619.00. Following registration of the Strata Plan on 17 July 2007, Menegazzo sought to complete the settlement of the property, without the intention of paying any money.  However the relationship had broken down between the directors and between Menegazzo’s parents. The sales of the other units in the development were greatly delayed, and when sold they did not realise the previously anticipated revenue.

On 25 July 2008 the Company was wound up, not for insolvency but because of the breakdown in the relationship of its directors. The Liquidator received a claim on behalf of Menegazzo to complete the Contract.  After investigation he declined to do so and sought to have the Contract declared void on the basis that it was an unreasonable director-related transaction.  The Liquidator was in possession of proofs of debt from creditors of the Company which exceeded its assets (namely cash at the bank).

(c) Decision 

The test for an unreasonable director-related transaction is set out in section 588FDA(1) of the Act. The critical question for the Court was whether paragraph 588FDA(1)(c) was satisfied as paragraphs 1(a) and 1(b) were clearly satisfied.  Section 588FDA(1)(c) provides that a transaction of a company is an unreasonable director-related transaction of the Company if it may be expected that a reasonable person in the Company’s circumstances would not have entered into the transaction, having regard to the factors left out in sub-paragraph (i) to (iv).

The court made the following assessment of the sub-paragraphs of paragraph 1(c):

(i) The benefits (if any) to the company of entering into the transaction

The benefits to the Company were negligible.  It contracted to sell the property which was considered to be valued at $425,000, for no real benefit to the Company.  It was to have received no payment at settlement. There was no legal obligation that John Menegazzo, upon receipt of the $40,000, was to pay that sum to the benefit of the Company, and that sum was paid at the time of the Contract, not settlement. There was nothing to suggest it was paid to the Company.  In addition, there was nothing to indicate that the repayment of the $130,000 loan was for the purposes of the Company.

The only possible benefit to the Company was the obligation undertaken by Menegazzo, on settlement, to rent the property at a market rent, however there was no obligation on John Menegazzo to pay the received rent to the Company, and therefore there was no benefit to the Company anyway. The Contract did not oblige Menegazzo to undertake any improvements or to make the property available for a display unit, or arrange for the letting of the property for holiday rentals. Even though Menegazzo did those things, he was not obliged to and therefore did not convey those benefits to the Company for the purposes of subparagraph (1)(c)(i).

(ii) The detriment to the company of entering into the transaction

The detriment to the Company of entering into the transaction was plain. The company disposed of a significant asset, to the benefit of John and Jill Menegazzo and possibly to Menegazzo, but for no real consideration to itself. In effect, it gave away a valuable asset.

(iii) The respective benefits to other parties to the transaction of entering into it

The transaction enabled Menegazzo to recover from his parents the indebtedness of $130,000, and correspondingly they were to be released from that indebtedness. John Menegazzo received $40,000. Although he spent money on the fit out, Menegazzo occupied the property rent free for most of the time since the Contract was executed, so the Company received no benefit from these actions.

(iv) Any other relevant matters

Underlying the transaction was the expectation of the Company that the development would be realised and provide a significant surplus of profits to the directors’ families through their respective family trust structures that were set up.  There was no reason to expect, at the time of the Contract, that those estimates would not come to pass in the relatively near future. However that revenue was not assured.  There were substantial outstanding liabilities, in particular the secured liability to the bank.

Bearing these factors in mind, the court concluded that a reasonable person in these circumstances would not have entered into the Contract. An order was made under section 588FF(1)(h) of the Act, declaring the Contract void at the time it was made.  As the Contract was an unreasonable director-related transaction, it was voidable under section 588FE(6A) of the Act because it was within four years of the relation-back day, that is four years from the date of the winding up of the Company on 25 July 2008.

The court made an order under section 588FF(4) of the Act for the purpose of recovering, for the benefit of the creditors of the Company, the difference between the total value of the benefits provided by the Company under the transaction, and the value (if any) that it may be expected that a reasonable person in the Company’s circumstances would have provided having regard to the matters referred to in section 588FDA(1)(c). The value of the benefits provided by the Company under the transaction was the value of the property, in effect its purchase price.

The court did not think it was necessary to make an order compensating Menegazzo for what he had spent on the property. He had lived rent free in the property and could recover the $130,000 loan amount and the $40,000 paid to his father as debts owed.

 

Co-authored by Michelle Batsas.

Published by SAI Global on behalf of Centre for Corporate Law and Securities Regulation, Faculty of Law, the University of Melbourne with the support of the Australian Securities and Investments Commission, the Australian Securities Exchange and the leading law firms.