Insolvency

Buying a power boat for the wife – not necessarily an unreasonable director related transaction, but only in the right circumstances

In 2013 a WA Supreme Court decision may have caught the attention of small company directors; it seemed using the company’s funds to buy that shiny new boat for the wife might not be a voidable transaction or breach of directors’ duties after all…

Unfortunately for some, that decision was quickly overturned by the Court of Appeal the subsequent year.  The appeal decision does not necessarily mean an extravagant private purchase by a company will always fall foul of the law in a subsequent liquidation,  but the occasions under which that may happen are confined to quite limited circumstances.

The background facts in the case of Weaver & Jones v Harburn [2013] WASC 441 were that:

• Peter Harburn was the sole director of Harburn Group Australia Pty Ltd;
• The sole shareholder of Harburn Group was a company associated with Mr Harburn, who held the shares as trustee for a family trust;
• Harburn Group provided financial services.   In effect Mr Harburn provided his personal financial planning services through the company;
• In  2007 Mr Harburn decided to reduce his workload,which he effected by selling his client base.  The sale agreement was entered on about 25 June 2007 and settled in July 2007 for $765,000.
• In about July 2007 Mr Harburn bought a $385,000 boat for his wife using Harburn Group’s funds.
• Harburn Group was subsequently wound up in April 2011.

The liquidators of Harburn Group sought recovery of the funds used to buy the boat.  The claim was put on two fronts; as a voidable unreasonable director related transaction under section 588FE(6A) Corporations Act 2001 (Cth), alternatively as a claim for damages for breach of the director duty provisions in sections 181 and 182 Corporations Act 2001 (Cth).

The Court at first instance

Unreasonable director related transaction

The Court first dealt with the voidable transaction claim.  Section 588FE of the Act provides that a transaction is voidable if (amongst other things) it is an unreasonable director related transaction of the company entered into in the 4 years prior to liquidation.  Section 588FDA of the Act provides that a transaction is an unreasonable director related transaction if (amongst other things):

• the transaction is a payment made by or disposition of the company’s property by the company,
• to the director or a close associate of the director,
• where it may be expected a reasonable person in the company’s circumstances would not have entered the transaction having regard to the benefits and detriments to the company of the transaction, the respective benefits to to other parties, and any other relevant matter.

The Court considered there was no doubt (i) the money transferred from Harburn Group to purchase the boat was a payment or disposition of the company’s property; and (ii) Mr Harburn’s wife was a close associate of the company’s director.  The remaining issue was whether ‘a reasonable person in the company’s circumstance would not have entered into the transaction’, considering the company’s circumstances at the time of the transaction (July 2007).

Notwithstanding there was no benefit to Harburn Group in purchasing the boat, and the purchase  caused detriment to Harburn Group (in that it had less money), what was considered highly relevant is that the company was not only solvent but comfortably solvent at the time of the transaction.  It had net assets of between $445,000 and $535,000 of which a significant portion was cash.  It was able to meet its rent through the balance of the 2007 calendar year, and was only wound up in 2011.   At the time of the transaction the future of Harburn Group was uncertain – it may have continued to trade indefinitely.  Mr Harburn was in complete control of the company; not needing to consult with anyone else about how the company’s funds were to be applied.

For these reasons the liquidators failed to establish that the transaction was unreasonable.

Directors duties

The Court then dealt with the claims of breach of sections 181 and 182 Corporations Act 2001(Cth).   Adopting views expressed by the High Court in Angas Law Services Pty Ltd (in liq) v Carabelas (2005) 226 CLR 507, the Court noted that the appropriation of a company’s assets by a director will not necessarily lead to a breach of the director’s duties.  The actions must be considered within their context and no inflexible rule should be imposed.

In then considering the commercial context the Court noted that Mr Harburn was the only director of the company and (importantly) ultimately the only person who could benefit from the company.  At the time of the transaction Harburn Group was solvent and there was no reason to believe it would become insolvent in future.  Just as the liquidators failed to establish that Harburn Group’s payment was an unreasonable transaction; so to they could not establish a breach of the directors duty provisions of the Act.

On appeal

The heart of the appeal in Weaver v Harburn (2014) 103 ACSR 416 was the relevance or weight to be given to the financial health of the company at the time of the boat transaction.

McClure P (Buss and Murphy JJA concurring) rejected the Master’s finding the director reasonably believed  the company was in a comfortable financial position at the time of the transaction.  For example:

• much of the company’s income in the relevant year was a once-off capital gain from the sale of the company’s business (financial planning client base);
• future income would be significantly reduced because of sale of the client base; and
• the company had a significant contingent CGT liability arising from the business sale which was yet to be quantified.

Accordingly, at best the company’s financial health was ‘uncertain’ at the time of the transaction and the director knew this.

Secondly, the Court considered whether the transaction could be reasonable even if the director believed the company was in good financial health.  Approving the decision in Slaven v Menegazzo [2009] ACTSC 94, the Court accepted the appellant’s argument the boat transaction was unreasonable regardless of the financial health of the company.  In essence, a transaction may be so objectively unreasonable that the financial position of the company at the time of entry into the transaction is not relevant.

Lessons

There are at least two lessons from this case at first instance and on appeal.

• On the one hand, the mere fact  the company’s assets were appropriated by the director for personal gain; and that the company suffered a detriment for the personal benefit of someone associated with the director, may not of itself be enough to sustain a claim against a director under section 588FE or sections 181 and 182 of the Act.

• On the other hand, to defend a claim the director may need not only to positively establish the good financial standing of the company into the short to medium future, but also provide a substantive and ‘reasonable’ reason for the ‘gift’ by the company.

An example of a transaction that might satisfy the test, is a ‘gift’ to fend off the risk of an equitable claim based on otherwise unrewarded contributions by a spouse or other third-party to the building up of the company’s income or assets.  Or a payment made by the company said to discharge some liability the recipient claims the company has.  It may be quite difficult to justify the transaction without the company having some form of liability (present or future, certain or contingent) that is discharged by the transaction. Presumably the size and nature of the gift/payment/transaction will play a part in objectively assessing its reasonableness from the company’s perspective.

Future cases will be left to decide what is and is not reasonable, on the particular facts of those cases.   These are already coming through, with liquidators successful in clawing back transactions in some cases, such as Smith v Starke, In The Matter of Action Paintball Games Pty Ltd (In Liq) (No 2) (2015) 109 ACSR 145 (paying loans for a third party), Golden Heritage Golf Pty Ltd (in liq) (recs and mgrs apptd) v Sun (2016) 113 ACSR 550 (offering loans with better security terms), and failing in other cases, such as Crowe-Maxwell v Frost (2016) 91 NSWLR 414 (personal expenses and other payments to directors).

Particularly when winding down a business and considering distributing the remaining assets personally, we recommend legal advice on the appropriate manner to do so (and whether it is appropriate to do so in the first place).

This article is general information only, at the date it is posted.  It is not, and should not be relied upon as, legal advice.  This article might not be updated over time and therefore may not reflect changes to the law.  Please feel free to contact us for legal advice that is specific to your situation.