TGIF 2 May 2025 – Full Federal Court clarifies requirements for voidable, unreasonable director-related transactions

In CEG Direct Securities Pty Ltd v Cooper (as liquidator) [2025] FCAFC 47, the Full Court of the Federal Court overturned a first instance decision and ultimately clarified the requirements for voidable, unreasonable director-related transactions.

Key takeaways

• A transaction may be considered voidable if it was made ‘for the benefit of’ a director of a company which is a party to that transaction, and if a reasonable person in the company’s position would not have entered that transaction.
  
  
• A transactional ‘benefit’ may include indirect benefits, such as the reduction of a director’s contingent liability under a separate agreement. However, even if a transaction does include a benefit to directors, it will only be voidable if it is unreasonable in the circumstances of a company and its related entities, and does not have a ‘commercial explanation’.
  
  
• A ‘commercial explanation’ for a transaction may be present where there is evidence that the company, related entities and third-party beneficiaries acted co-operatively, where the beneficiary directors do not receive any proceeds from the transaction, and/or where the beneficiary directors have committed no wrongdoing.

Background

This case centres around an appeal made by CEG Securities (CEG), the mortgagee, against the primary judge’s decision that the grant of a mortgage (the Runtong Mortgage) was an unreasonable director-related transaction within the meaning of section 588FDA of the Corporations Act 2001 (Cth) (Corporations Act). (We covered this decision in a previous TGIF.)

The plaintiff company Runtong Investment and Development Pty Ltd (now in liquidation) (Runtong) was incorporated in 2012 for the purposes of purchasing land in Adelaide (the Runtong Property). The purchase was financed by NAB on the security of a mortgage granted in October 2012.

Between September 2014 and December 2014, Runtong’s related companies Datong and Futong, executed three separate loan agreements with CEG as lender. Runtong, Datong and Futong shared two common directors, Jin Liang and Ping Huang (the Runtong Directors). The Runtong Directors had both provided personal guarantees to CEG for the repayment of the borrowed funds. In December 2014, the Runtong Mortgage was executed as a second mortgage over the Runtong Property to secure the borrowings of Datong and Futong.

After Runtong defaulted on the mortgage, CEG entered into possession of the Runtong Property in February 2018 as mortgagee in possession. By March 2018, administrators were appointed, and by June 2018 the creditors had resolved to wind up Runtong and ultimately appointed one of the administrators, Nicholas Cooper, as liquidator. CEG subsequently exercised its power of sale over the Runtong Property.

At trial, the liquidator submitted that the Runtong Mortgage was an unreasonable director-related transaction pursuant to section 588FDA(1) of the Corporations Act because it had the effect of reducing the Runtong Directors’ personal liabilities under the three loan agreements executed between CEG, Datong and Futong. It was therefore alleged that the mortgage was for the benefit of the directors.

The liquidator also alleged that a reasonable person in Runtong’s position, having regard to all the relevant circumstances, would not have granted the Runtong Mortgage to CEG. Conversely, CEG argued that Runtong, Datong and Futong were part of a ‘property development group’, which provided a reasonable commercial explanation for granting the Runtong Mortgage.

Primary Judge’s decision

At trial, O’Sullivan J held that the mortgage was an unreasonable director-related transaction and voidable on that basis. His Honour concluded that:

• The word ‘benefit’ should be construed broadly when considering unreasonable director-related transactions and should extend beyond benefits which are direct and immediate. Therefore, the Runtong Mortgage was for the benefit of the Runtong Directors.
  
  
• A reasonable person in Runtong’s position would not have executed the Runtong Mortgage as it offered no discernible benefit to Runtong and exposed it to potential liability for over $15 million.

On Appeal

The Full Court of the Federal Court of Australia unanimously allowed CEG’s appeal and overturned the first instance decision.

Under the first ground of appeal, CEG submitted that the primary judge had construed the idea of benefit too broadly and that the phrase ‘for the benefit’ means a ‘net benefit’ to the director (Ground 1). Accordingly, a transaction will not be ‘for the benefit’ of a director unless it can be shown that their net position has improved because of the transaction.

The Court unanimously dismissed Ground 1. The majority (Cheeseman and McEvoy JJ) stated that such a narrow interpretation of ‘benefit’ did not accord with the text, context and purpose of the legislation and was unnecessarily complex, especially as the directors’ net position in relation to contingent liability is not always known at the time of entering a transaction.

Under the second ground of appeal, CEG submitted that the primary judge erred in concluding that, on the totality of the evidence, a reasonable person in Runtong’s circumstances would not have granted the Runtong Mortgage (Ground 2). CEG argued that the primary judge had not considered all of Runtong’s circumstances and all relevant matters.

The Court unanimously allowed Ground 2. Contrary to the primary judge’s finding, the majority found that Datong, Futong and Runtong operated as a property development group which acted cooperatively in financing each other’s respective developments. Runtong was a special purpose vehicle which was entirely dependent on funding from Datong, Futong and associated entities in China – meaning there was an imperative to enter into the Runtong Mortgage.

While there was limited evidence of the nature or purpose of the Runtong Mortgage transaction, the commercial reality of the relationship between Runtong and its related entities meant that entering the Runtong Mortgage was not a departure from normal commercial practice.

Ultimately, the Court was satisfied that the evidence objectively established a commercial explanation for Runtong’s entry into the Runtong Mortgage. The Runtong Mortgage was, therefore, not a voidable transaction.

Comment

It is important to note that the transaction, which was the subject of this proceeding, related to a previous but substantially similar version of section 588FDA(1) of the Corporations Act. Nevertheless, this case provides important guidance for liquidators in scrutinising potentially unreasonable director-related transactions, especially in cases where security is provided by related entities in a corporate group.

When determining if a transaction was unreasonable, a court will consider the relative benefits and detriments of a transaction in the commercial context in which the company was operating – as opposed to the exact statutory relationship between related companies. Where a company is entirely dependent on its related entities for funding, a transaction providing important security for the related entities’ borrowings may be reasonable – even where the transaction incurs significant liabilities.

For directors who are considering whether to grant security to support related entities in distressed situations, the takeaway is to reflect on, and be prepared to provide, a commercial explanation of the benefit of entering into the transaction for each separate party.