Trying to pull a fast one: An attempt to use family law orders to defeat creditors

Family law processes cannot be used to defraud creditors. In Re ZH International Pty Ltd (in liq),[1] the Supreme Court of New South Wales held that transfers of property from a company to the directors and shareholders of that company as part of family law proceedings were voidable transactions under section 588FF of the Corporations Act 2001 (Cth) where the company was not a party to the orders and the orders did not require the company to make the transfers.

Background

The defendants were formerly married. They were also the directors and shareholders of a company, ZH International Pty Ltd (the Company), which owned a number of properties located in Cabramatta, Sydney, secured by mortgages. The Company paid $1.43 million for these properties in 2003 and 2004.

The defendants claimed that they had contributed $1.238M to the purchase price of the properties and produced a Shareholders Loan Account which they said established the contributions. Contrary to this assertion, the Court held that the books and records of the Company, including this loan account, were unreliable and did not comply with section 286 of the Corporations Act 2001 (Cth) (the Corporations Act).

In 2010, the Company obtained a building licence, and attempted to build several residential developments. These developments had numerous problems, with a local government shutting one down. Building defects claims exceeding $3 million were commenced against the Company in 2013.

In 2011, the marriage between the defendants broke down. In 2014, the defendants obtained consent orders from a registrar under the Family Law Act 1975 (Cth) (the Family Law Act). The Company was not a party to the proceeding nor was it mentioned in the orders.

Purportedly in accordance with the family law orders, in September 2014 the defendants caused the Company to transfer two properties to each of the defendants. The Shareholder Loan Account was also purportedly repaid.

The Company’s equity in the properties in September 2014 was just over $2 million. The Company was then in severe financial difficulties, and this equity was its principal source of funds.

Westpac obtained a judgment against the Company, which led to Orders that the Company be wound up on 13 September 2016.

By May 2021, the value of the properties had increased to $6.62 million.

The proceeding

The liquidator sought orders under section 588FF of the Corporations Act that the transfers of the properties and the repayment of the Shareholder Loan Account were voidable transactions. They also sought orders for re-transfer of the properties to the Company.

Because the liquidator was concerned that section 588FF only provided for an order reflecting the value of assets at the time of the transaction, the liquidator alternatively sought equitable compensation to capture the value of the properties at the time of judgment.

The defendants argued that the transfers had occurred under an Order pursuant to section 79 of the Family Law Act, and therefore were not transactions of the Company for the purposes of section 588FF. They argued that orders of the Court pursuant to the Family Law Act had required the transfers to take place, and that the Court could not make orders inconsistent with those orders.

The Court observed that the family law orders required each of the defendants to transfer all of their interests in the properties to the other defendant. However, neither of the defendants had any interests in the properties, which were owned by the Company. There was therefore no inconsistency between the family law orders and the orders sought in the proceeding.

The Court found that the Company was insolvent when the properties were transferred to the defendants.

The Court held that, even if the Shareholders Loan Account was accurate (which the Court doubted), the Company received $1 million less than its equity in the properties. This was at a time that the Company was in severe financial difficulties and the only likely source of funds was the equity in the properties.

The Court held that each transfer was an unreasonable director related transaction under section 588FDA, an uncommercial transaction under section 588FB, an unfair preference under section 588FA and an insolvent transaction under section 588FC. The Court commented that the entire scheme had been implemented to defeat the Company’s creditors.

The Court made Orders under section 588FF, observing that there is nothing in the wording of the section to prevent the Orders from capturing the value of the properties at the date of judgment. The equitable compensation claim was therefore unnecessary.

Key takeaway

The Court will not permit directors and shareholders to abuse the processes of family law to defraud creditors or defeat the voidable transaction provisions of the Corporations Act.

Orders under section 588FF of the Corporations Act can be used to capture the benefits of assets the subject of a voidable transaction at the time of judgment, and are not limited to orders reflecting the value of assets at the date of the voidable transaction.

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Authored by:

Scott Couper, Partner
Craig Melrose, Associate

[1] [2022] NSWSC 2.