Guide to Unreasonable Director-Related Transactions
- Justeen Dormer
- Mar 23
- 5 min read
Insolvency
When a company faces financial distress, a liquidator is appointed to manage its affairs and ensure assets are distributed fairly among creditors. One crucial part of this process involves examining past transactions to identify any that may have unfairly disadvantaged the company. An unreasonable director-related transaction is one such type of transaction that liquidators can investigate and seek to recover.
At Dormer Stanhope Lawyers, we specialise in corporate law and insolvency matters. We provide expert guidance to directors and companies navigating these complex legal landscapes. This guide explains what constitutes an unreasonable director-related transaction under the Corporations Act 2001, how they are identified, and what the consequences are.
What is an Unreasonable Director-Related Transaction?
An unreasonable director-related transaction occurs when a company enters into a deal that provides little or no benefit, or is detrimental to the company, and involves a director or a close associate of a director. The purpose of the law is to prevent directors from using their position to improperly shift company assets to themselves or related parties, especially when the company is in financial trouble.
Under corporate law, if a liquidator successfully proves a transaction was unreasonable, the court can order the other party to return the asset or pay compensation to the company.
Who Can Recover These Transactions?
Only a company's liquidator has the power to pursue unreasonable director-related transactions. This action is not available to provisional liquidators, voluntary administrators, or other controllers. The liquidator's primary role is to maximise the assets available for distribution to the company's creditors. Investigating and recovering value from unreasonable transactions is a key part of fulfilling this duty.
The Core Elements of the Claim
For a liquidator to successfully make a claim for an unreasonable director-related transaction, they must prove three fundamental elements:
A transaction involving the company occurred.
The transaction involved a director, a close associate of a director, or a nominee.
A reasonable person in the company’s position would not have entered into the transaction, considering the lack of benefit or the detriment it caused.
Let’s explore these elements in more detail.
1. The Transaction
The term 'transaction' is broad. It can include a payment of money, the transfer of property, providing a security interest over an asset (like a mortgage), or even incurring an obligation to do any of these things in the future. Essentially, section 588FDA of the Corporations Act is designed to capture any situation where value leaves the company or its assets are encumbered for the benefit of a related party without a proper commercial return.
2. The Parties Involved
The transaction must have been made with one of the following parties:
A director of the company.
A close associate of a director.
A person acting as a ‘nominee’ for a director or their close associate.
A director is not just someone formally appointed to the role. The definition under section 9 of the Corporations Act also includes individuals who act as a director (a de facto director) or whose instructions the board is accustomed to following (a shadow director).
A close associate is defined as a relative of a director or their de facto spouse. This includes spouses, parents, children, siblings, and even relatives of the director's spouse.
A nominee is someone who participates in the transaction on behalf of the director or close associate, often to disguise the true beneficiary of the deal. The law looks past the superficial structure to see who actually received the benefit.
How is a Transaction Deemed 'Unreasonable'?
The key test is whether a reasonable person in the company's circumstances would have entered into the transaction. The court assesses this by weighing the benefits to the company against the detriment it suffered. If the detriment outweighs the benefit, the transaction is likely to be considered unreasonable.
This is an objective test. The court considers what a hypothetical reasonable person, aware of the company's financial position and circumstances, would have done. A reasonable person would not knowingly enter a transaction that causes a net loss to the company's assets or provides a personal benefit at the company's expense.
Crucially, the company does not need to have been insolvent at the time of the transaction. This is a significant point of difference from other liquidation claims, such as insolvent trading or uncommercial transactions. Because insolvency is not a required element, common defences like 'acting in good faith' or having 'no reasonable grounds to suspect insolvency' do not apply to these claims.
Time Limits for Unreasonable Transactions
A liquidator can only review transactions that occurred within a specific timeframe. The transaction must have been entered into:
Within four years before the ‘relation-back day’.
Between the relation-back day and the date the winding up began.
The ‘relation-back day’ is a critical date in any liquidation and varies depending on how the process started:
Court Liquidation: The day the winding-up application was filed with the court.
Creditors’ Voluntary Winding Up: The day the members passed a resolution to wind up the company.
Following a Voluntary Administration: The day the administrators were first appointed.
What Relief Can a Liquidator Obtain?
If a court finds that an unreasonable director-related transaction has occurred, it can make orders under section 588FF of the Corporations Act. The most common order is for the recovery of the value lost by the company.
It is important to note that the liquidator can only recover the excess benefit. The court calculates the difference between the value the company gave and the value it received. For example, if a company sold a property worth $500,000 to a director’s spouse for $200,000, the liquidator could seek to recover the $300,000 difference.
The entire transaction is not automatically voided unless there was no reasonable part to it at all. The court’s goal is to restore the company to the financial position it would have been in had the unreasonable transaction not occurred.
How Long Does a Liquidator Have to Make a Claim?
A liquidator must commence legal proceedings for an unreasonable director-related transaction within three years of the relation-back day. Simply sending a letter of demand is not enough; a formal court application must be filed within this period.
Expert Guidance on Director Transactions and Corporate Law
Navigating the complexities of director duties and liquidation claims requires specialist legal knowledge. Whether you are a director seeking to understand your obligations or a liquidator investigating potential recovery actions, the rules surrounding unreasonable transactions are stringent.
The team at Dormer Stanhope Lawyers has extensive experience in corporate law, insolvency, and commercial litigation. We provide clear, authoritative advice to help you understand your position and navigate your legal obligations with confidence. If you are facing issues related to director transactions or liquidation claims, contact us for expert support.
