Voidable Transactions: When Can a Liquidator Unwind a Company Transaction?

Voidable transactions can become a significant issue when a company enters liquidation after making payments, transferring assets or entering into settlements while experiencing financial distress. Transactions that appeared legitimate or commercially necessary at the time may later be investigated by a liquidator and, in certain circumstances, challenged and unwound under Part 5.7B of the Corporations Act 2001 (Cth).

Two important, but non-exhaustive, categories are unfair preferences and uncommercial transactions. While both can involve transactions entered into while a company is insolvent, they address different concerns. An unfair preference focuses on whether one unsecured creditor received an advantage over other creditors, while an uncommercial transaction asks whether a reasonable person in the company’s circumstances would have entered into the transaction at all.

When Does a Transaction Become Voidable?

Under s 588FC, an unfair preference or uncommercial transaction is an “insolvent transaction” where the company was insolvent when the transaction was entered into or given effect to, or became insolvent because of it. Section 588FE then determines whether that transaction is voidable. An ordinary unfair preference generally attracts a six-month look-back period, while an insolvent uncommercial transaction may be challenged within two years before the relation-back day.

Unfair Preferences: Did One Creditor Receive More?

Under s 588FA, an unfair preference arises where a transaction results in an unsecured creditor receiving more in respect of its debt than it would have received if the transaction were set aside and the debtor is winding up.

The focus is therefore whether the creditor obtained an advantage over the general body of unsecured creditors.

This becomes more complicated where the creditor continued supplying the company while receiving payments. In Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2, the High Court confirmed that s 588FA(3) embodies the “running account” principle. Payments forming an integral part of a continuing business relationship are treated as one transaction, with the commercial relationship assessed objectively as a whole.

The Court also rejected the “peak indebtedness rule”: a liquidator cannot select the highest point of indebtedness merely to maximise the preference claim. The single transaction instead begins with the first transaction after the later of the statutory period commencing, insolvency arising, or the continuing relationship beginning. Importantly, payments directed only towards recovering past debt may fall outside the relationship: the inquiry is whether they were connected with future supply, rather than merely “looking backwards”.

Uncommercial Transactions: Was the Deal Commercially Rational?

A different question arises under s 588FB. A transaction is uncommercial where a reasonable person in the company’s circumstances would not have entered into it, having regard to the benefits and detriments to the company, benefits to other parties and other relevant matters.

The inquiry is objective. Courts have described the provision as targeting transactions at an undervalue and bargains so commercially abnormal that ordinary commercial practice cannot explain them. A transfer of valuable business assets to satisfy a substantially smaller existing debt, for example, may raise issues independently of whether the recipient was preferred.

What Happens if a Transaction Is Voidable?

Where an unfair preference or uncommercial transaction is found to be voidable, s 588FF gives the Court broad powers to restore the position for the benefit of creditors. This may include ordering a recipient to repay money, return property or compensate the company for benefits received under the transaction.

For unfair preferences specifically, the High Court confirmed in Metal Manufactures Pty Limited v Morton [2023] HCA 1 that a creditor cannot use the set-off provisions in s 553C to reduce its liability to repay a preference by the amount that the company still owes it. The creditor must restore the preference and then prove for its underlying debt through the ordinary liquidation process.

Recipients of either an unfair preference or an uncommercial transaction may nevertheless have protection under s 588FG where, broadly, they entered the transaction in good faith, lacked reasonable grounds for suspecting insolvency and provided valuable consideration or changed their position in reliance on the transaction.

The practical lesson is that parties dealing with financially distressed companies should consider not only whether a transaction appears commercially justified when entered into, but whether it could later be challenged as having preferred one creditor or depleted assets otherwise available to creditors generally.

Need Advice?

At Leo Lawyers, we understand that dealings with financially distressed companies can expose creditors, landlords, suppliers and other counterparties to unexpected insolvency risks. Payments or asset transfers that appear commercially reasonable at the time may later be challenged by a liquidator as unfair preferences or uncommercial transactions. We assist clients to assess the risks associated with transactions entered into before insolvency, respond to liquidator demands and understand the options available to protect their position where a transaction is alleged to be voidable.

Feel free to contact Damin Murdock at Leo Lawyers via our Website, on (02) 8201 0051 or at office@leolawyers.com.au. Further, if you liked this article, please subscribe to our newsletter via our Website, to our YouTube, LinkedIn, Facebook and Instagram, and kindly give us a favourable Google Review.

DISCLAIMER: This is not legal advice and is general information only. You should not rely upon the information contained in this article and if you require specific legal advice, please contact us