How Can a Liquidator Recover ‘Unfair Loans’?

Here we look at one of the less common forms of ‘voidable transaction’; the ability of a liquidator to claw back a transaction that was an ‘unfair loan’ to the debtor company. We explain why it is relatively rare for liquidators to recover funds under this provision. 

Voidable transactions

On insolvency, the liquidator has a primary (though not sole) interest in increasing the pool of liquidated assets of the company for eventual distribution. This is not only to improve outcomes for unsecured creditors in general, it also increases the likelihood that the liquidator themselves will get paid out of those proceeds. Voidable transactions include: 

• Unfair preference payments. These are payments by the debtor company, preferring one creditor over others, where the company directors had notice of the company’s insolvency (note, generally speaking, these claims will only be successful when the transaction in question happened in the 6 months prior to liquidator appointment).
• Uncommercial transactions. These are transactions which are ‘under-valued’. Transactions where it was unreasonable for the company to enter into them, having regards to the benefits and detriments of doing so. Generally speaking, in order to be voidable, the transaction needs to have occurred within the 2 years prior to liquidator appointment.
• Unreasonable director-related transactions. These are transactions between the company and a director or their associates which are to the benefit of that director (or their associates) and to the detriment of the company as a whole. Generally speaking, the transaction must have occurred with the four years prior to appointment of the liquidator. 

What is the definition of an unfair loan?

Under section 588FD of the Corporations Act 2001 (Cth), a loan to a company is unfair if, and only if: 

• the interest on the loan is, or was, extortionate; or 
• the charges in relation to the loan (such as a mortgage or a personal property security) are, or were, extortionate. 

Under that same section, in determining whether either aspect of the loan (the interest or the charge) was extortionate, the court will consider the following factors: 

• the risk assumed by the lender;
• the value of any security;
• the term of the loan;
• the schedule for payments of interest, charges, and repayment of the principal; and
• any other relevant matter. 

Two aspects of an unfair loan claim that might be thought to make them attractive from the point of view of the liquidator are: 

• as with unreasonable director-related transactions, there is no requirement that the loan was made while the company was insolvent at the time; and 
• there is no set time period during which the loan must have occurred.

What is the purpose of the unfair loans provision? 

In the original explanatory memorandum that accompanied the introduction of this provision, it was stated: 

“This provision is quite different from anything contained in the present law and is directed to the situation where the rights of unsecured creditors as a class are prejudiced by the company’s having entered into a loan agreement for which the consideration is excessive.”

And:

“The section is not directed to loans which in hindsight may be judged as bad bargains but at transactions which are grossly unfair” [para 1048].

To some extent, this definition is intended to distinguish this test from general contractual restrictions appealing to ‘unfairness’ such as the restriction on ‘unfair contract terms’ contained in the Australian Consumer Law. There, the test for unfairness appears to be easier to meet (arguably reflecting the greater protections that the law intends for consumers than it does for businesses). 

The equivalent section in UK insolvency legislation involves a prohibition on “extortionate credit transactions” (section 244 of the Insolvency Act 1986 (UK)).  There, the restriction is on credit contracts where: 

• the terms require or required grossly exorbitant payments to be made; or
• the terms grossly contravene ‘ordinary principles of fair dealing’. 

How have the courts interpreted the ‘unfair loans’ provision?

It might be thought that the more measured language in the Australian legislation (relative to the UK) might indicate that Australian courts would be more willing to find a loan to be unfair, than they would in the UK. There is not an explicit requirement for the courts to find that any terms were “grossly exorbitant”, or that they “grossly contravened” expectations for fair dealing. 

However, where this section has been litigated in Australia, the Courts have set a high bar for what will count as an ‘unfair loan’. The courts have tended to take a holistic picture of the transaction to determine whether it is ‘extortionate’, rather than focusing on any of the individual factors listed in that section. 

For example, this provision was considered in Emanuel Management Pty Ltd & Ors v Foster’s Brewing Group Ltd & Ors [2003] QSC 205. While the Court found that the section did not directly apply, as the loan in question pre-dated the enactment of the ‘unfair loans’ provision, the Court nevertheless considered what the conclusion would be if that provision were to be applied. 

In that case, the plaintiff had failed to repay an initial loan, and the defendant had agreed to a new loan with a hefty ‘profit sharing’ fee of $2,000,000, effectively doubling the total fee that the defendant charged for the loan.  

The Court observed that this provision would not be ‘extortionate’, as it was “the price [the plaintiffs] had to pay to avoid the loan becoming overdue and immediately repayable”. In the Court’s view, this term simply recognised the additional risk to the plaintiff in lending to a company which had previously failed to repay. 

In Re Essendon Apartment Developments Pty Ltd (In Liquidation) (No 2) [2013] VSC 210, the Court assessed a loan in relation to a second mortgage, with interest rates of 60% per annum, or 72% per annum if in default. Did these interest rates necessarily make it an unfair loan?

The Court found that there was not an unfair loan. The Court was swayed by the fact that: 

• The lender was exposed to high risk — the mortgage was a second mortgage on an undeveloped project;
• There was no evidence of the value of the security; 
• The loan was for only three months; and 
• The loan was only for $120,000.

In light of the Court’s reluctance to make ‘unfair loan’ findings, it remains a relatively under-utilised liquidator tool.