Uncommercial transactions: not all about undervaluation

In the recent case of The Old Kiama Wharf Company Pty Ltd (in liquidation) v Betohuwisa Investments Pty Limited & Anor [2011] NSWSC 823, the liquidator of The Old Kiama Wharf Company Pty Ltd (OKW) sought to set aside a transaction between OKW and Betohuwisa Investments Pty Limited (Betohuwisa) on the basis that it was uncommercial under s 588FB(1) of the Corporations Act 2001 (Cth).

The transaction

The catalyst for the transaction was a statutory demand served on OKW by its major creditor to enforce a judgment debt against OKW for $1.2 million. Mr Colbron (the second defendant) sought to transfer OKW’s assets to Betohuwisa, a newly formed company of which his daughter, Mrs Hamilton, was sole director, secretary and shareholder. The transaction was effected by Mr Colbron’s de facto partner and sole director, shareholder and secretary of OKW. Whilst Mr Colbron was not a named officer of either company, it was clear that he was controlling the actions of both OKW and Betohuwisa.

Betohuwisa purchased OKW’s two businesses and leasehold interest for $475,000. Betohuwisa also granted a mortgage back of its newly acquired leasehold interest to OKW. However, no funds in connection with the transfer and the mortgage back ever actually changed hands. Furthermore Betohuwisa did not have the resources to pay the purchase price nor capacity to meet its mortgage obligations.

Decision regarding the transaction

Pembroke J acknowledged that although undervaluation is the most common indication of an uncommercial transaction, it is not the only consideration. Indeed, the purchase price of $475,000 was $50,000 more than a valuation obtained by Mr Colbron. Rather, it is necessary to consider whether a reasonable person in the company’s circumstances would have entered into the transaction, by weighing up the factors listed in s 588FB(1).

The factors are:

• the benefits (if any) to the company of entering into the transaction;
• the detriment to the company of entering into the transaction;
• the respective benefits of entering into the transaction to the other parties; and
• any other relevant matter.

His Honour held that, as a result of the transaction, OKW suffered significant detriment. OKW was deprived of its sole assets, with no likelihood of payment from Betohuwisa. On the other hand, Betohuwisa benefited substantially. It acquired effective control and ownership of OKW’s businesses, while OKW was left with significant debts and liabilities to creditors.

In addition, Pembroke J held that all parties acted solely at the direction of Mr Colbron, exercising no independent judgment. His Honour held that transaction was not conducted at arms length and the “controlling minds” of the entities were “involved or related”, rendering the transaction uncommercial.

Pembroke J concluded that the transfer was a “transparent stratagem” designed to defeat OKW’s creditors and preserve its assets, and thus ordered that the assets be re-transferred from Betohuwisa to OKW.

Comments

Although valuation is a good indicator as to whether a transaction is uncommercial, it is not determinative. The Court will decide whether a transaction is uncommercial by considering whether a reasonable person in the company’s circumstances would have entered into the transaction, having consideration to the factors listed in s 588FB(1). In addition to these factors, the Court will also consider if the transaction has been entered into at arm’s length.