Implications for liquidators and lenders 10 min read
Last year, we published an Insight on a Federal Court decision where the plaintiff liquidator was successful in having a mortgage declared an unreasonable director-related transaction under s 588FDA of the Corporations Act 2001 (Cth) (the Act). Earlier this year, the defendant mortgagee, CEG Direct Securities (CEG), successfully appealed the decision before the Full Court.
Last week, the High Court refused special leave to appeal from the Full Federal Court's decision, meaning the decision stands as the leading authority on s 588FDA.
Key takeaways
- For a transaction of a company to be an unreasonable director-related transaction, it must be made 'on behalf of, or for the benefit of' a director or a person otherwise identified in s 588FDA(1)(b). In this context, the phrase 'for the benefit of' has a wide construction, extending to indirect, contingent and secondary benefits accruing to the director in question.
- While s 588FDA remains an additional 'tool' for clawing back assets the subject of cross-securities, where there is limited evidence of the nature and purpose of the relevant transaction, liquidators should carefully assess the adequacy of their evidence before relying on the provision.
- The liquidator is required to establish the condition in s 588FDA(1)(c) that a reasonable person in the company's circumstances would not have entered into the transaction. Whether a liquidator has discharged that onus will be determined having regard to their statutory powers to compel relevant evidence.
- The Full Federal Court's decision should provide lenders taking cross-securities with some relief following the primary decision. However, lenders should keep clear records of the circumstances of, and surrounding, each transaction, including the commercial interrelationship between the grantor entity and any borrowing entity.
Background
What happened?
Runtong Investment and Development Group Pty Ltd (Runtong) was involved in property development and was the registered proprietor of land in Adelaide, South Australia (the Property). In October 2014, as part of its acquisition of the Property, Runtong obtained financing from a bank (Bank) on the security of a first mortgage over the Property.
Subsequently, in December 2014, Runtong granted a second mortgage over the Property to CEG (CEG Mortgage) to secure existing and further loan advances totalling over $15 million from CEG by two property development companies, Australian Datong Investment & Development Group Pty Ltd (Datong) and Futong Investment and Development Pty Ltd (Futong), with whom Runtong shared two common directors. The CEG Mortgage was a part of a series of securities provided to CEG to secure Futong and Datong's borrowings, and supplemented personal guarantees previously given by the two common directors.
In June 2018, Runtong's creditors resolved to wind up Runtong and appointed a liquidator. In July 2018, CEG, as mortgagee in possession, entered into a contract for the sale of the Property. CEG realised about $12 million from the exercise of its power of sale under the CEG Mortgage.
The liquidator brought proceedings against CEG claiming that the grant of the CEG Mortgage was an unreasonable director-related transaction under s 588FDA, on the basis that it was made for the benefit of the common directors by reducing their contingent liability under their personal guarantees.
Structure chart
Legislative framework
Section 588FDA outlines a three-stage test to determine whether a transaction is an unreasonable director-related transaction. It requires:
- a transaction;
- that the transaction be made either to a director or on behalf/for the benefit of a director (or relative of a director, or spouse); and
- that a reasonable person in the company's circumstances would not to have entered into the transaction, having regard to the factors set out in s 588FDA(1)(c).
It is an objective assessment. Notably, this provision does not require that the company be insolvent.
The decisions
In this case, there was no dispute that the grant of the CEG Mortgage was a 'transaction' and the key issues for determination at trial and on appeal were:
- Was there a benefit provided to the directors of Runtong?
- Would a reasonable person in Runtong's circumstances not have granted the mortgage?
Primary judgment (Justice O'Sullivan)
The primary judge was satisfied the reduction in contingent liability under the director guarantees was a benefit provided to the Runtong directors.
The primary judge considered that the word 'benefit' in s 588FDA(1)(b)(iii) meant 'both direct and indirect benefits' and captured any legal and financial advantages to the director in question. The primary judge was satisfied that the CEG Mortgage was for the benefit of the Runtong directors insofar as their contingent liability under the director guarantees would be reduced by whatever amount CEG would eventually receive from realising its mortgage over the Runtong Property.
The primary judge was satisfied a reasonable person in Runtong's circumstances would not have entered into the CEG Mortgage.
In his decision, the primary judge emphasised the inadequacy of the evidence in relation to Runtong's circumstances, including as they existed at the time the CEG mortgage was granted. Despite this, the primary judge was satisfied that a reasonable person in Runtong's circumstances would not have entered into such a transaction.
In reaching his decision, the primary judge rejected evidence led by CEG in support of its contention to the contrary. CEG primarily relied on an expert report by Ms Karam, a chartered accountant and forensic accounting specialist, and business records subpoenaed by CEG from the Bank.
In her report, Ms Karam opined that it was common practice of lenders to take cross-securities from related entities, and that Runtong's grant of the CEG Mortgage was reasonable in the circumstances as they existed at that time. Relevantly:
- Ms Karam's opinion on the reasonableness of the transaction rested on the fundamental assumption that Runtong, Datong and/or Futong were part of a 'property development group', a matter which she concluded from business records subpoenaed by CEG from the Bank; and
- The Bank's business records presented a chronological narrative of the Bank's assessment of the three companies' circumstances, in its capacity as their principal lender. The records showed that the Bank treated the companies as an aggregate group, under the name 'Australian Datong Group'.
While accepting that the three companies could be 'related entities' by reason of their common directors, the primary judge was not satisfied on the evidence that they formed a part of a 'property development group'. In this regard, his Honour noted the absence of identifiable holding company and placed little, if any, weight on the Bank's documents.
Without finding that a 'property development group' existed, the primary judge did not accept Ms Karam's opinion evidence and concluded that the evidence did not reveal any adequate commercial explanation for the CEG mortgage, nor any benefit to Runtong.
Full Court judgment (Cheeseman and McEvoy JJ, and Goodman J)
The primary judge had not erred in finding that the CEG Mortgage was a disposition made for the benefit of the Runtong directors.
On appeal, CEG submitted that the primary judge had erred in his construction of 'for the benefit of' in s 588FDA(1)(b). However, the Full Court rejected the confined construction advocated for by CEG and, consistent with the primary decision, that 'benefits' included those that were 'indirect, contingent and secondary', in line with the anti-avoidance purpose of s 588FDA.
The Full Court also rejected CEG's submission that the primary judge had erred by finding that the grant of the CEG Mortgage was made for the benefit of the Runtong directors. CEG argued that because the net effect of the transaction was that the contingent liability of the Runtong directors increased under the director guarantees, there was no 'benefit' to them for the purpose of the provision.
The Full Court found CEG's proposed 'net benefit' construction introduced complexity and uncertainty into the provision (as contingent liabilities is not a fact that can necessarily be known at the date of transaction), and did not align with the provision's text, context and purpose.
The primary judge erred in finding that a reasonable person in Runtong's circumstances would not have entered into the CEG Mortgage.
The Full Court was unanimous in its decision to allow the appeal on the basis that the primary judge had erred in concluding that the liquidator had discharged his onus to establish the negative proposition in s 588FDA(1)(c). However, Cheeseman and McEvoy JJ, and Goodman J delivered different reasons for allowing the appeal.
The key legal principles considered across both judgments included:
- The inquiry under s 588FDA(1)(c) is concerned with the reasonableness of the company’s conduct, objectively assessed by reference to the company’s circumstances and encompassing all relevant matters. Each element of s 588FDA(1)(c)(i) to (iii) is a mandatory consideration.
- The liquidator bore the onus of proving the negative proposition in s 588FDA(1)(c).
- In circumstances where a party bears the legal onus of proving a legal proposition produces sufficient evidence from which the negative proposition may be inferred, the evidentiary onus shifts to the other party to adduce evidence that tends to show that the negative proposition is not true.
The court was divided in relation to whether the evidence led by the liquidator was sufficient to shift the evidentiary burden of proving the negative condition in 588FDA(1)(c) to CEG.
Cheeseman and McEvoy JJ found that:
- The liquidator's evidence that Runtong provided the CEG Mortgage, in circumstances where it was not a named borrower under the relevant loan, was sufficient to shift the evidentiary onus to CEG.
- CEG discharged its evidentiary onus. As limited as it was, the evidence led by CEG was sufficient to establish a commercial rationale for Runtong's entry into the CEG Mortgage.
- The primary judge had erred in declining to draw inferences which were available on the evidence which, taken in combination, provided a commercial explanation for the transaction. In this regard, in contrast to the primary judge, the majority placed significant weight on Ms Karam's expert opinion and the Bank's treatment of the companies as a group in its business records.
- Crucially, the evidence available was sufficient to draw the inference that the three companies were acting cooperatively in financing and staging their respective developments and were in effect working as a 'property development group'. The documentary evidence demonstrated that Runtong was dependent on external funding from related entities like Datong and Futong, whom in turn obtained funding from the Bank and CEG.
- That the companies could not be strictly described as 'related body corporates' under the Act (because no holding company could be identified) was no impediment to this finding. The primary judge had allowed the statutory definitions to distract from the substantive task of evaluating the commercial relationship between the three companies.
Goodman J found that:
- The evidence before the primary judge did not provide a satisfactory basis to make a finding as to what Runtong's circumstances were when it granted the CEG Mortgage, much less a finding that a reasonable person in such circumstances would not have granted the mortgage.
- The evidentiary onus never shifted to CEG because the evidence led by the liquidator regarding Runtong's circumstances did not demonstrate a departure from normal commercial practice.
- The primary judge incorrectly attributed responsibility for the lack of evidence in the case to CEG rather than to the liquidator. It was for the liquidator, not CEG, to produce evidence of Runtong's circumstances, as he possessed greater means to obtain that evidence by virtue of statutory powers.
High Court decision
In disposing of an application by the liquidator for an extension of time within which to seek special leave to appeal from the Federal Court's decision, the High Court refused special leave to appeal with costs. The full extent of the High Court reasoning is set out below:
'The outcome of the proceedings turns on the analysis of particular facts to s 588FDA(1) of the Corporations Act 2001 (Cth) and does not raise any broader question of principle. Otherwise, there is insufficient reason to doubt the correctness of the decision of the Full Court to warrant a grant of special leave to appeal. It would therefore be futile to grant the extension of time that is sought.'
Note from the authors: The case is CEG Direct Securities Pty Ltd v Cooper as liquidator of Runtong Investment and Development Pty Ltd (in liq) [2025] FCAFC 47. The citation for the special leave disposition is [2025] HCADisp 196.