Unreasonable director-related transactions: can the available remedies be ordered in the case of a solvent company?
Aviation 3030 Pty Ltd (in liq) v Lao, in the matter of Aviation 3030 Pty Ltd (in liq) [2022] FCA 458
Can the remedies available for an unreasonable director-related transaction under section 588FDA of the Corporations Act 2001 (Cth) (Act) be awarded in the case of a solvent company? This was the key legal question in the recent case of Aviation 3030 Pty Ltd (in liq) v Lao, in the matter of Aviation 3030 Pty Ltd (in liq) [2022] FCA 458. Ultimately, Justice Anastassiou answered this question in the affirmative.
Background
Liquidators were appointed to Aviation 3030 Pty Ltd (Company), following winding up orders made in March 2019, upon application by ASIC (ASIC v Aviation 3030 Pty Ltd [2019] FCA 377). The Company was solvent at the time of those winding up orders being made. A proceeding was brought by the Company’s liquidators in March 2020 against various directors and shareholders of the Company and their associates.
Facts
The Company was incorporated by Hakly Lao and Khay Suong Taing (Founding Shareholders) in May 2011 as a joint venture to purchase land near Point Cook, Victoria for $7.8 million. Other shareholders invested in the Company in or around 2011 (Early Investors) to help fund acquisition of the land.
In September 2012, the Company purported to grant to the Founding Shareholders (or their respective nominees) options to purchase up to 160 million shares in the Company. These options were granted by an option agreement that annexed a letter dated May 2011, which purported to record a grant by the company of the options on the same terms. The exercise price of these options was $0.001 per share. Neither the May 2011 letter nor the option agreement was disclosed to the Early Investors.
In March 2016, the Company issued 152 million shares at a price of $0.001 per share, which was below market value at the time, to interests associated with the Founding Shareholders (Share Issue).
In October 2018, the Company contracted to sell the land for $135 million, at a profit of approximately $127 million. Settlement is to occur in April 2023.
Issues
The central issues in the case were whether the Share Issue constituted an unreasonable director-related transaction contrary to s 588FDA of the Act and, if so, the consequences that flowed from that.
Relevant legislation
Section 588FDA of the Act sets out the test for whether a transaction of a company is an unreasonable director-related transaction, in circumstances where a relevant payment, disposition or issue is, or is to be, made by the company to a director or their close associate (or for the benefit of either a director or their close associate). Section 588FF(4) of the Act allows the Court to make orders in relation to an unreasonable director-related transaction to recover for the company’s creditors the difference between the benefit provided by the company and the value that a reasonable person in the company’s position would have provided.
Findings
Was the Share Issue an unreasonable director-related transaction?
Yes. The Share Issue substantially diluted the value of existing shareholders’ interests in the Company because of the low price at which the options were to be exercised. This occurred in circumstances where the existing shareholders (the Early Investors) had not been properly informed via adequate disclosure that this was to occur before they acquired their shareholdings.
Was there scope for relief under s 588FF(4) of the Act?
The defendants argued that, as the Company was solvent, there was no creditor who might benefit from the recovery of money. This submission turned upon the meaning of ‘creditors’ in s 588FF(4) of the Act.
First, the judge held that the natural meaning of ‘creditors’ includes anyone to whom any obligation may be owed. Second, his Honour stated that a shareholder is one class of creditor of the company. Where a company is solvent, shareholders are entitled to the return of their share capital and to a distribution of any surplus. Third, his Honour held that there is no reason to distinguish between creditors generally and one class of creditor (a shareholder) for the purpose of the recovery of the difference in value under s 588FF(4). Shareholders are just as likely to be harmed by an unreasonable director-related transaction as external creditors. The fact that a claim pursuant to s 588FDA does not require that the company be insolvent recognises that such transactions may arise regardless of the solvency of the company. Therefore, his Honour held that it would be incongruous that there be a remedy under s 588FDA for external creditors, but not for the benefit of shareholders.
What was the appropriate relief?
The dilution of the value of the shares held by the Early Investors rendered the Share Issue an unreasonable director-related transaction. The judge held that the appropriate remedy was to notionally assign an option exercise price equivalent to the median price at which the shares were acquired by the Early Investors ($0.12 per share). By imputing a notional price of $0.12 per share to the shares issued to the primary remaining defendant, Lao Holdings (other defendants had settled the proceedings with the plaintiffs), there would be no material dilution of the value of the shares issued to the Early Investors. The impact on the Founding Shareholders was $9,044,000, representing the price that they had to pay for not adequately disclosing the proposed Share Issue and thus diluting the value of the shares held by the Early Investors when the options were exercised.
Orders
Justice Anastassiou ordered Lao Holdings to pay the additional sum of $9,044,000 to the Company, to be set off against the future distribution to which Lao Holdings will be entitled. The plaintiffs, as liquidators, are required to distribute the total sum between all shareholders (including Lao Holdings) once the Company has been wound up.
