1. What is insolvency?
Insolvency is defined in section 95A of the Corporations Act 2001 (Cth)(Act) as the inability of a company to pay its debts when they fall due. Australian law applies a cash-flow test rather than a balance-sheet test, meaning the inquiry does not turn on the numerical gap between assets and liabilities.
The key question is whether the company has, in practice, the means to obtain the funds required to pay its debts. ASIC has listed common indicators of insolvency, but none of them is conclusive by itself, and they must be assessed together in context. For example, even if a company has no cash on balance, it may still be solvent if it has a reliable ability to quickly raise funds.
There is also no set period into the future that directors must assess when considering solvency. The relevant timeframe depends on the size and nature of the company’s debts and the characteristics of its business. For example, a well-established company with a strong record of repayment and capital access may still be solvent without a specific plan for payment three months ahead. But a start-up with limited funding options may be insolvent even if its next major debt is not due for more than a year.
To provide some clarity, section 588E of the Act recognises certain presumptions of insolvency. First, when a company has failed to keep proper financial records that accurately reflect its financial position, courts may treat the absence of records as evidence of insolvency during the relevant period. Second, if insolvency has already been established in another proceeding, that prior finding may be relied upon as a presumption of ongoing insolvency. Third, if insolvency was proven or presumed at any point within the 12 months ending on the relation-back day (which is typically tied to the date of the winding-up application or resolution), that state is presumed to have persisted from that point forward up to the relation-back day. These presumptions operate as practical indicators used by the courts to assist the assessment of solvency.
2. What are different types of voidable transactions and what is relation-back day?
At the outset, there are four categories of voidable transactions: insolvent transactions; unreasonable director-related transactions; unfair loans; and creditor-defeating dispositions. Insolvent transactions further include two sub-types, unfair preferences and uncommercial transactions.
Where a transaction falls within any of the voidable transaction categories, it may be set aside through an application by the liquidator to the court, provided that the transaction occurred within the applicable hardening period. The length of that period will depend on the nature of the transaction and the identity of the counterparty. In general, transactions involving related parties are subject to a longer review period. The specific timeframes are as follows:
- Unfair preference: 6 months for non-related parties and 4 years for related parties.
- Uncommercial transaction: 2 years for non-related parties and 4 years for related parties.
- Unreasonable director-related transaction: not applicable to non-related parties and 4 years for related parties.
- Unfair loan: no statutory time limitation for either category.
- Creditor-defeating disposition: 12 months for both non-related and related parties.
The hardening period is calculated by reference to the relation-back day. For example, where the applicable period is six months, a transaction may be set aside if it occurred in the six months before the relation-back day, or in the period between that day and the commencement of the winding up. The relation-back day is determined by the circumstances outlined in section 91 of the Act and, in practice, is usually tied to either the filing date of any winding-up application, the appointment of a voluntary administrator or the passing of a resolution to wind up.
3. What are unfair preferences (section 588FA of the Act)?
An unfair preference arises when a company pays an unsecured creditor shortly before winding up, and that payment results in the creditor receiving more than they would have received if the payment were reversed and the creditor instead proved in the winding up.
To establish an unfair preference, four elements must be shown. First, insolvency must be established. Second, the claim must relate to an unsecured creditor. Third, the liquidator must identify the relevant transaction. Fourth, it must be shown that the creditor received more than they would have received if the transaction were undone and they were instead paid in the ordinary course of the winding up. The discussion that follows will focus on the latter two elements.
3.A. What is ‘transaction’?
The term ‘transaction’ is defined very broadly and extends to any arrangement that gives rise to legal consequences. By way of guidance, section 9 of the Act includes examples such as the giving of guarantees, the incurring of obligations and the making of loans. These examples assist in illustrating the concept, but the list is not exhaustive. Notably, a company may still be treated as a party to a transaction even where it was not directly involved in each component of the arrangement.
Where there is a continuing business relationship between the company and a creditor, the transactions within that relationship are treated as a single transaction. For example, if under that ongoing account the company had paid $100 to the creditor and the creditor subsequently provided $50 of value back to the company, the net effect is a $50 preference. In practice, court often implements the ‘peak indebtedness rule’ to assess the preference amount, which is the difference between the highest amount owing during the period and the amount owing on the last day of that period.
3.B. What is unfair?
Determining the fairness requires comparing what the creditor actually received with what they would receive if the transaction were reversed and they had to stand in line with all other unsecured creditors in the real liquidation.
Notably, it is not a correct approach to ask what the creditor might have received if the company had been wound up on the day the payment was made. That early or hypothetical winding-up can produce unrealistic results, because the true position of creditors and liabilities may not yet have crystallised at that point.
4. What are uncommercial transactions (section 588FB of the Act)?
Liquidators can recover money or property transferred under an uncommercial transaction not only from creditors, but from any party to the transaction. A transaction is regarded as uncommercial where, viewed objectively, a reasonable person in the company’s circumstances would not have entered. In determining this, consideration is given to the commercial benefit or detriment to the company, the benefit received by the other party, and any other relevant circumstances.
Like unfair preferences, to establish an uncommercial transaction, the liquidator must identify the relevant transactions, which may cover a broad range of matters, and prove that the company was insolvent at the time. However, rather than showing that the creditor received a preferential benefit, the liquidator must demonstrate that the transaction is uncommercial.
4.A. What is uncommercial?
The assessment of commerciality is made objectively and considering the company’s actual financial circumstances. While an uncommercial transaction often involves a transfer at an undervalue, that is not a strict requirement. In a Queensland case, a company transferred all its assets to its directors, who then used those assets to pay every creditor except two. The court found the transaction to be uncommercial because it was structured for the sole purpose of excluding those two creditors, and this is not a normal commercial practice.
4.B. What are liquidators’ alternatives when uncommercial transactions arise?
In many cases, an uncommercial transaction will also give rise to a breach of directors’ duties, particularly where directors have failed to act in the best interests of the company or have preferred their own interests. These breaches give liquidators an additional basis for recovery and allow them to pursue directors personally for loss suffered by the company.
For public companies, where the transaction involves a related party, the approval regime under Chapter 2E of the Act may also apply. If a related-party benefit was provided without the required shareholder approval, or if the company could not show a clear commercial benefit, this may further support the liquidator’s position that the transaction should be set aside, and value should be restored to the company for the benefit of creditors.
5. What are unreasonable director-related transactions (section 588FDA of the Act)?
An unreasonable director-related transaction captures benefits provided to a director or their close associate that fall outside proper commercial conduct. In this situation, insolvency does not need to be proven. The regime is designed to prevent directors from extracting value from the company in ways that a reasonable person in the company’s circumstances would not consider proper.
Liquidators must establish the core statutory elements: first, there must be a transaction; second, the benefit must have been received by a director or a close associate; and third, a reasonable person would not have agreed to the transaction having regard to the benefits and detriments to the company.
Notably, the assessment of reasonableness is made at the time the company actually enters the transaction. Even if at an earlier point the company had incurred a contractual obligation, the law requires the reasonableness of the act to be assessed as at the time of performance rather than inception.
6. What are unfair loans (section 588FD of the Act)?
Unfair loans are loans that were extortionate at the outset or subsequently became so as a result of variation. As with director-related transactions, establishing insolvency is not required. Instead, the court will assess whether the terms are objectively unfair by examining factors such as the lender’s risk exposure, the adequacy of security, the loan term, the payment profile, and related commercial circumstances.
However, the threshold for judicial intervention is high. In a liquidation case, the liquidator contended that a mortgage was unfair, pointing to an interest rate of 60 to 72 per cent per annum. The court accepted that the rate was exceptionally high but nonetheless found that, considering the substantial commercial risk undertaken by the lender, the mortgage did not reach the level of extortionate or unconscionable conduct necessary for the court to set it aside.
7. What are creditor-defeating dispositions (section 588FDB of the Act)?
Creditor-defeating dispositions consist of two elements: firstly, the consideration received by the company is less than market value or less than the best price reasonably obtainable in the circumstances; secondly, the disposition has the effect of denying or diminishing the value that would otherwise be available to creditors. Importantly, no subjective intention to disadvantage creditors is required, both elements are assessed by reference to an objective standard.
8. What are available defences for voidable transactions (section 588FG of the Act)?
Some statutory protections are designed to prevent legitimate commercial dealings from being unwound unfairly. Broadly, the Corporations Act provides two categories of defences: one for persons who were not parties to the transaction, and another for persons who were parties to the transaction. Notably, these defences are not available in respect of unreasonable director-related transactions or unfair loans.
8.A. What are defences for a person who is not a party to the transaction?
The defence for a person who was not a party to the transaction is most relevant to third-party recipients such as creditors, guarantors, or persons whose property rights might otherwise be affected by a clawback order. Courts will not make an order against such a person if it can be shown either that they did not receive any benefit from the transaction, or that if they did receive a benefit, they did so in good faith, had no reasonable grounds to suspect the company was insolvent, and where a reasonable person in the same position would also have had no such grounds.
Some cases demonstrate this principle in practice. In one instance, a company director purchased an engagement ring using company funds and later gave it to his fiancée. Although she received the benefit of the ring, she played no role in authorising the company’s expenditure and had no knowledge of the circumstances of the payment. The court regarded her as a non-party for the purposes of the defence, emphasising that the voidable transaction regime does not extend liability to individuals who merely receive a benefit without participating. The rationale is that a person who did not contribute to the transaction and had no reason to suspect insolvency should not be burdened by the consequences of it.
8.B. What are defences for a party to the transaction?
Where a person seeking protection was a direct party to the transaction, the law provides a different form of defence. In this context, the party must affirmatively establish a series of statutory conditions, and the defence will only apply if each of those elements is satisfied. The underlying theme is that the law shields parties who engaged in legitimate commercial dealings and who did so honestly and without awareness of the company’s deteriorating financial position.
8.B.1 Good faith
The first requirement is that the party entered into the transaction in good faith. This refers to the party’s honesty and genuine belief that the transaction was commercially proper. The inquiry focuses on the person’s subjective state of mind at the time. For example, if a supplier accepted payment believing it was part of an ordinary trading relationship and had no reason to think the company was in financial distress, that would commonly indicate good faith. The defence will not assist a party who actually knew that the company could not pay its debts or who acted with an awareness that the transaction was being used to prejudice other creditors.
8.B.2 No reasonable suspicion of insolvency
The second requirement is that the party must not have had reasonable grounds to suspect insolvency, and that a reasonable person in the same circumstances would also not have had such grounds. This involves both a subjective and objective standard. Additionally, suspicion requires more than mere curiosity, it involves a real sense of apprehension or doubt about solvency. For example, if payments were routinely late, communications suggested financial strain, and the creditor internally recognised these issues as signs of insolvency, the defence may fail. Conversely, if delays were reasonably attributed to administrative or isolated operational issues, and the overall circumstances did not create mistrust, suspicion may not be established.
8.B.3 Valuable consideration or change of position
The next requirement is that the party must have provided valuable consideration or changed their position in reliance on the transaction. Valuable consideration must be real and meaningful, though it need not be equal to the value transferred by the company. In most commercial settings, this will be satisfied where the party supplied goods, services, capital, or extended credit. Importantly, the legislation expressly provides that where a payment has been made to discharge a tax liability, that discharge is deemed to constitute valuable consideration. This ensures that government revenue authorities are treated as having provided consideration for tax payments and may rely on the defence where the other elements are met. Alternatively, even if no consideration was provided, a party may still satisfy this requirement if they materially changed their position in reliance on the payment or the rights conferred by the transaction.
8.B.4 What if the transaction forms part of a running account?
When payments occur within a running account, an important question is when the elements of good faith and lack of suspicion of insolvency should be assessed. Some earlier case law suggested that the creditor must show that they acted in good faith and without suspicion for the entire duration of the running account, right up until the last payment. However, that view has weakened over time. Later judicial decisions have recognised that a running account can continue even where there is some awareness or suspicion of financial stress. The law has therefore not settled firmly on the precise timing for assessing good faith in this context.
One practical suggestion in the commentary is that a liquidator should only be able to select the peak indebtedness point at a time after the running account defence is no longer available. In simple terms, this means a liquidator should not be able to pick a point when the creditor was still trading with the company in good faith and without reasonable suspicion of insolvency. This approach better reflects commercial reality and helps avoid unfair outcomes for suppliers and other creditors who continued to support the business through legitimate trading activity.
8.C. What is the common law doctrine of ultimate effect?
The doctrine of ultimate effect is commonly used by creditors in defending an unfair preference claim. It allows the court to look at the practical result of the payment rather than its immediate form. A creditor can rely on this principle where they can show that the payment formed part of a continuing trading relationship and that they continued to supply goods or services that brought value back to the company. In these circumstances, the payment may not be treated as preferential because it supported the company’s operations. By contrast, where a payment only reduced an existing debt and did not lead to any ongoing supply or benefit, the doctrine will not apply, and the liquidator may seek to recover it.
9. What orders the court may give to the liquidators (section 588FF of the Act)?
It is important to recognise that a voidable transaction is not automatically undone. To unwind such a transaction, the liquidator must obtain a court order. The court may make a range of remedial orders, including an order requiring repayment of money received under the transaction or the return of property transferred as a result of it. The court may also order a person to compensate the company for the value of any benefit they received. Importantly, the court also has power to vary the terms of an agreement, ensuring that any continuing terms are adjusted fairly to reflect commercial reality and creditor interests. These orders are designed to restore the company to the financial position it would have been in had the improper transaction not taken place.
10. Why Ironbridge Legal?
Uncertainty around insolvency, the complexity of the voidable transaction framework, and the different grounds of defence create real risk for liquidators, creditors and company directors. Navigating these disputes requires not only a technical understanding of the Act, but also the ability to apply commercial judgment to each situation and to act strategically in time-sensitive circumstances.
At Ironbridge Legal, our work is shaped by experience in running and defending these claims across a wide range of industries and financial structures. We understand how regulators, liquidators and courts approach these issues, and we know how to position our clients to secure the best possible outcome. Whether the matter involves recovering payments, defending against a clawback claim, examining director conduct or negotiating a restructuring pathway, we approach it with the speed, clarity and precision that these disputes demand.
If you require assistance or wish to evaluate your position in relation to a potential voidable transaction or insolvency-related claim, we are ready to support and guide you through each stage of the process.
Further Information
For further information about proofs of debt, voting at creditors’ meetings, DOCA, and challenges to voluntary administration outcomes, please contact the author of this article:
Blake Shaw
PARTNER
