TGIF 11 October 2019: The mythical legal phoenix: Court asks who will really benefit from the restructure?

This week’s TGIF considers the decision in ACN 093 117 232 Pty Ltd (In Liq) v Intelara Engineering Consultants Pty Ltd (In Liq) [2019] FCA 1489, where the Court determined that a transaction described as a ‘legal phoenix’ by the advising practitioner was, in fact, an uncommercial transaction and an unreasonable director related transaction.

What happened?

The company formerly known as Intelara Pty Ltd (Intelara) operated an engineering consultancy business.  It owned certain plant and equipment and intellectual property and had over 30 employees.  It’s banking facilities were secured in part by personal guarantees given by its two directors.  

From early 2014, Intelara experienced financial difficulties.  

In late 2015, the directors obtained advice concerning the potential restructuring of Intelara. That advice included a plan to implement a “legal phoenix” by establishing a new corporation to which the assets and employees of the existing business would be transferred.   A liquidator would then be appointed to wind up Intelara and the remaining assets used to discharge major creditors, including the ATO and Intelara’s bank.

The restructuring plan was implemented and on 7 December 2015 two things occurred: Intelara entered into an asset sale agreement with Intelara Engineering Pty Ltd (Engineering) and was then placed into liquidation by a resolution of its members.  Engineering had the same directors (who were also the ultimate shareholders) as Intelara.

A previous edition of TGIF considered the decision of the Federal Court to appoint a special purpose liquidator (SPL) to investigate and pursue any claims arising in relation to the asset sale agreement and sets out additional background relevant to this proceeding.

PRESENT PROCEEDING

The asset sale agreement included terms that:

• The purchase price was $1;
• Settlement would take place on 7 December 2015;
• Certain assets, being plant and equipment, fixtures and fittings, intellectual property and work in progress were transferred to Engineering; and
• Engineering agreed to acquire employees entitlements of 26 employees and the directors in the sum of $459,574.61.

Only 44 days later, Engineering was placed into liquidation by a resolution of its members.

Here the SPL seeks declarations under the voidable transactions regime of the Corporations Act 2001 (Cth).

Decision

Leave was granted to proceed against Engineering, despite it being in liquidation, and the proceeding was not defended by Engineering’s liquidator.  

This means that the Court’s determination was made without the benefit of a contradictor.  However, Derrington J commented that the strength of the evidence gave him no cause for concern in exercising the Court’s discretion and making the declarations sought.  Many of the facts relied on by the SPL had been admitted by the directors in the course of public examinations.

The SPL also submitted that the declarations would mark the Court’s disapproval of the conduct displayed in this case.  While the Court did not think it necessary to rely on that submission here, it was noted there may be some basis to do so in cases of this nature.

Ultimately, the Court found that the asset sale agreement comprised:

1. An uncommercial transaction pursuant to section 588FA of the Act;
2. An insolvent transaction pursuant to section 588FC of the Act;
3. An unreasonable director-related transaction pursuant to section 588FDA of the Act; and
4. A voidable transaction pursuant to section 588FE of the Act.

In finding that the transaction amounted to an uncommercial transaction, the Court noted that Intelara’s assets were transferred for effectively nil consideration and that there was no real benefit to Intelara while a substantial benefit was afforded to the directors by reason of the release of their personal guarantees given to the bank.

The second of these points was given closer analysis in determining that the transaction also amounted to an unreasonable director-related transaction.  Derrington J said that the requirement in section 588FDA(1)(b) that the disposition of the company’s property be to a director or for the benefit of a director was sufficiently made out here.  His Honour went on to say that the benefit conferred on the directors from the release of their personal guarantees appears to be a benefit of the type contemplated by this provision.

The Court also ordered that the former employees who had been transferred under the asset sale agreement may prove in the winding up of Intelara for the entitlements owing to them as if their employment had been terminated at the time of the winding up.

Comment

In Derrington J’s previous decision to appoint the SPL, he commented on the word ‘restructure’ was being used to cover a variety of sins in the insolvency and restructuring industry.   With the further evidence adduced in this application, it is clear that the ‘restructuring’ plan was, incredibly, described by the relevant practitioners as a ‘legal phoenix’.  

This decision clearly demonstrates that a transaction of the type described here is not within the bounds of the current insolvency regime in Australia.  The Court has, again, sounded a warning to insolvency practitioners when operating in the restructuring and pre-appointment advice space and the market more generally that transactions are not protected from scrutiny simply because they were entered into with the benefit of professional advice.