When being related is not enough: Cant v Mad Brothers Earthmoving Pty Ltd [2020] VSCA 198

In Cant v Mad Brothers Earthmoving [2020] VSCA 198, the Court of Appeal of the Supreme Court of Victoria has clarified the application of the unfair preference regime in the Corporations Act 2001 (Cth) to payments made by third parties at the direction of a debtor to its creditors.  In short, a payment to a creditor by a third party at the direction of the debtor will not be ‘from’ the debtor unless the payment diminishes the assets available to the debtor’s other creditors.

Background

The liquidator of Eliana Construction and Developing Group Pty Ltd (the Debtor) sought to claw back a $220,000 payment made to one its creditors, Mad Brothers Earthmoving Pty Ltd (the Creditor).  The Debtor had previously engaged the Creditor to perform earthworks at various construction sites in Victoria.  The Debtor did not pay for the works, and the Creditor filed winding up proceedings in the Supreme Court of Victoria. 

In settlement of those winding up proceedings, Rock Development & Investments Pty Ltd (the Related Company), made the payment to the Creditor  The payment was made using money borrowed from Nationwide Credit Pty Ltd secured over the Related Company’s assets.  The Related Company owned some of the land on which the Creditor had performed works.

The exact relationship between the Debtor and the Related Company was in issue on appeal.  However, it was clear that the companies shared a bank account, and, at the time of the payment, shared a sole director. 

Transaction that is an unfair preference under s 588FA(1)

The Court considered whether the payment described above was a ‘transaction’ to which the Debtor was a party. It also considered whether the payment met the two requirements for a transaction to be an unfair preference under ss 588FA(1)(a) and (b): that the debtor and creditor are parties to the transaction, and that the transaction’s effect is that the creditor receives ‘from the company’ more than they would have, had they proved their debt in the winding up.  It was not in dispute that the Creditor received more than it would have in the liquidation. 

The Court held that the definition of ‘transaction’ in s 9 ‘readily extends to a dealing by which the third party authorises or ratifies that person’s conduct in making the payment’ and that in such circumstances, ‘[t]he third party is a party to that transaction’: [42].  As such, the Court upheld the primary judge’s finding that the Debtor was a party to the transaction.

In relation to s 588FA, the Court reviewed the legislative history of the provision and its predecessors and apparently conflicting authorities from the Federal Court[1] and the Supreme Court of New South Wales.[2]  The Court ultimately concluded at [120] that a debtor may be party to a transaction for the purpose of s 588FA(1)(a) by giving a direction, ratifying, or authorising a payment from a third party to a creditor.  However, this alone is not sufficient to make the payment ‘from the company’ within the meaning of s 588FA(1)(b).  Rather, the payment must be from assets to which the debtor is entitled. It is necessary that the payment has the effect of diminishing the assets of the company available to creditors.

The Court upheld the primary judge’s finding that the Debtor was a party to the transaction.  The Debtor’s general ledger recorded an amount exceeding the amount owed to the Creditor as having been ‘paid off’ by the Related Company and the companies shared a sole director. 

The Court then considered whether the payment was one ‘from’ the Debtor.  In issue was whether, as a question of fact, the payment was made from monies to which the Debtor was otherwise entitled, and therefore satisfied the requirement set out above.  The liquidator claimed the Debtor was owed unpaid progress payments under a joint venture between it, the Related Company and a third party.  However, the Court held there was insufficient evidence to establish the indebtedness in the manner claimed.

Although the above findings were sufficient to dispose of the appeal, the Court went on to consider the Creditor’s good faith defence under s 588FG(2).  The Court held at [165] that a reasonable person in the position of the Creditor would have ‘harboured an apprehension or mistrust of [the Debtor’s] solvency’ at the time of the transaction.  Although the Debtor’s long-term accountant believed the company was solvent, it was apparent that a ‘cash injection’ was needed to meet the Debtor’s debts.  Another creditor had also commenced a winding up proceeding.  Therefore, the Court would have allowed the appeal on the basis that the good faith defence under s 588FG(2) would not have been established, had it not already found against the liquidator on the application of s 588FA.

Conclusion

The Court of Appeal has clarified an area of uncertainty in the application of s 588FA to related party payments.  Whether in practice a given payment falls within this regime will require careful consideration of the extent of the debtor’s involvement in the transaction and whether it has affected the debtor’s assets available to other creditors.

[1] Burness v Supaproducts Pty Ltd [2009] FCA 893; 259 ALR 339 (Gordon J).

[2] Re Evolvebuilt Pty Ltd [2017] NSWSC 901 (Brereton J).