Pragmatism from the Victorian Supreme Court; when a transaction that elevates an unsecured creditor to a secured creditor will not be considered uncommercial

The Liquidators appointed to the company known as 640 Elizabeth Street Pty Ltd (“640”) have recently tested the boundaries of the Court’s opinion of a benefit received in connection with an uncommercial transaction.

In 640 Elizabeth Street Pty Ltd (in liq) &Ors v Maxcon Pty Ltd[2015] VSC 22the Liquidators of 640 sought to recover an uncommercial transaction.However, the Victorian Supreme Court dismissed the appeal, finding on nearly all grounds against the Liquidators.

Both the Defendant,Maxcon Pty Ltd (“Maxcon”),and the Plaintiff Liquidators agreed that the principles governing the application of s588FB of the Corporations Act 2001(Cth)were well established. Pointing to Capital Finance Australia Ltd v Tolcher[2007] FCAFC 185 and Lewis (as liquidator of Doran Constructions Pty Ltd (in liq)) v Doran (2005) 219 ALR 555 it was agreed that s588FB requires a balancing of the benefits and the detriments of the transaction in question.

In this case, the transaction involved the granting of a mortgage by 640 to the construction company Maxcon at a time when it was insolvent,arguably for no apparent consideration or benefit to 640. The questions about whether there was a benefit from the transaction involved a consideration of whether 640 avoided litigation by entering into the transaction and if so, did that constitute a ‘benefit’ to 640 for the purposes of the Corporations Act2001 (Cth)?

In assessing whether 640 had received a benefit from the transaction, the Supreme Court considered the indirect benefit received by 640 from the avoidance of litigation by Maxcon. Ultimately the Court found that in granting the mortgage, 640 had avoided an exposure to litigation,and that this was undoubtedly of benefit to 640.

In assessing whether 640 had suffered a detriment from the transaction as a result of the elevation of Maxcon to secured creditor, the Supreme Court commented that the proceeds recovered under the mortgage provided would have been paid to Maxcon in any event.

The Background

1. 640 and Jabbour 640 Pty Ltd (“Jabbour”) entered into a joint venture deed (“JV Deed”) for the development of apartments at 640Elizabeth Street, Melbourne, Victoria (total value when completed being $30.7 million).

2. Elan Apartments Pty Ltd (“Elan”) was appointed as the Development Manager.

3. Elan entered into a building contract with Maxcon to build the 54 residential apartments for a contract price of $14,750,000.

4. At that point, the developers under the JV Deed, being 640 and Jabbour, did not have any direct dealings with the builder Maxcon.

5. In breach of the building contract, Elan failed to cause the retention monies to be retained ($350,000) and allowed those monies to be used by 640 to discharge its secured debt to the Bank.

6. Maxcon regarded this use of the retention monies by 640, with the permission of Elan,as theft and a clear breach of contract by Elan.

7. Under the JV Deed, 640 had given Elan an indemnity against, for example, any liabilities arising under the building contract Elan had with Maxcon.

8. The dispute was resolved by a Deed of Acknowledgement which included a clause forbearing Maxcon from suing for breach of the building contract, and a charging clause whereby 640 was to charge all of its land with the payment of amounts due by Elan to Maxcon.

The Benefit

The Liquidators submitted to the Supreme Court that the Trial Judge was erroneous in finding that the avoidance of litigation by Elan was of benefit to 640 because there was no evidence that Elan would have defended any litigation brought by Maxcon. The Liquidators said there was no foundation for a finding that the avoidance of the costs of litigation by Elan (which were arguably subject to the indemnity from 640) and consequent diminished profits available to 640, constituted a benefit to 640.

Further, the Liquidators submitted that despite their close relationship,640 and Elan were separate entities and that there was no basis of a claim by Maxcon as against 640, separate from Elan.This was a critical issue in determining that there was no unfair preference, as there was no debtor/creditor relationship between 640 and Maxcon at the time of the transaction.

For the Liquidators it was difficult to comprehend how the avoidance of litigation by Elan (a related company) was of itself alone a direct benefit to 640. The building contract in dispute was with Elan and not 640. The Liquidators submitted that in those circumstances any security granted by 640 to Maxcon was not done to secure a benefit to 640 (being the avoidance of litigation) as there was no immediate or apparent threat of litigation against 640.

However, the Supreme Court found that given the relationship between Elan and 640, particularly the indemnity clause and the existence of an agency, 640 was undoubtedly exposed to a claim for the amount being sought by Maxcon.

The exposure was said to be so strong that 640 was in the gun. The Supreme Court found that, but for the transaction in question,legal action would have been taken against one or both of the companies and costs would have been incurred by 640. Those costs would have been paid with priority out of the gross receipts of the JV development,pursuant to the JV Deed, thereby unavoidably reducing 640’s profits. Avoiding that exposure was found to be of clear benefit to 640.

The Detriment

The Liquidators submitted that what was otherwise an unsecured contractual liability to Maxcon had been elevated to a secured liability to the obvious prejudice of the unsecured creditors of 640.

The Supreme Court looked to the terms of the JV Deed to see how the gross proceeds of the sale of the development would otherwise have been distributed. The Supreme Court found that, as a result of the provisions of the JV Deed the gross proceeds of the sale of the apartments were to be held in a trust account by Elan, as the JV Development Manager, for 640 on terms that the debts of Elan, such as those to Maxcon,were to be paid first before any JV surplus would be distributed from that account to 640 (or its creditors).

Accordingly, whether Maxcon was paid from the trust funds in accordance with the terms of the JV Deed or pursuant to the disputed mortgage granted by 640, the result to the unsecured creditors of 640 was the same. There was no detriment to their position. The gross proceeds of sale would never get back to 640 as an asset free of any burden or encumbrance and therefore[be]available to its unsecured creditors.

The Lesson for Liquidators

From this case we see that the Courts are willing to assess detriments and benefits in the context of uncommercial transactions with a very wide interpretation.

Liquidators will need to think laterally and look at the ultimate (possibly indirect) results of a transaction before pursuing claims under Part 5.7B Division 2 of the Corporations Act 2001(Cth).