In June 2018, Runtong entered liquidation.  It owned vacant CBD land, subject to a mortgage to NAB, and intended to ultimately build a residential apartment tower on that land.

There were 2 companies related to Runtong: Futong and Datong, which shared some common directors with Runtong.

Futong also owned separate CBD land and was part-way through a construction of a residential apartment tower on its land.  Futong and Datong had borrowed from CEG to fund the construction costs.  The directors (including those that were common to Futong, Datong and Runtong) had given personal guarantees to CEG for Futong and Datong’s borrowings.

In December 2014, Runtong executed a mortgage in favour of CEG as part of a series of securities provided to CEG to secure Futong and Datong’s borrowings, which at that time was approx $15 million.

In July 2018 CEG, as mortgagee in possession, sold Runtong’s land for approx $12 million.

Runtong’s granting of the mortgage to CEG was ultimately held by the Court to be a void unreasonable director-related transaction within the meaning of s. 588FDA of the Corporation Act.

The Court can declare void such a transaction where the company concerned enters liquidation and the transaction is within 4 years of the relation-back day; and the transaction was a payment to or a transaction for the benefit of a director of the company.  There are other criteria, including that a reasonable person in the company’s circumstances would not have entered into the transaction, having regard to:

the detriment to the company of entering into the transaction; and the respective benefits to other parties to the transaction.

In this case, the Court found that Runtong’s granting of the mortgage to CEG was a benefit to its directors in that their contingent liabilities under their prior personal guarantees to CEG (for Futong and Datong’s borrowings) would be reduced by whatever net sum CEG received from realising its security over Runtong’s land.

This was the finding notwithstanding that CEG later advanced monies to fund building works on Runtong’s land (which were not completed by the time Runtong entered liquidation).

The granting of the mortgage to CEG was a detriment to Runtong as it had the effect of Runtong incurring an obligation to make a disposition of its property.

There are 2 important aspects to this case:

1)         Indirect benefits to directors

In a similar case, Vasudevan v Beacon Constructions (Australia) Pty Ltd [2014] VSCA; (2014) 41 VR 445, it was held that the “benefit” to directors could be either a direct benefit or an indirect benefit.  In that case, the director personal guarantees were extinguished by the relevant transaction.  In Runtong, however, while the directors’ personal guarantees were not extinguished by the transaction, there was an indirect benefit to the directors of having their contingent liabilities under their prior personal guarantees reduced by whatever net sum the mortgagee received from realising its security over Runtong’s land.

2)         Common lending practices

In Runtong, the defendant lead evidence that it was common practice of lenders to take cross-securities from related entities.  It argued that Runtong’s granting of the mortgage was within part of acceptable lending practices and therefore it was reasonable for Runtong to have granted the mortgage to CEG.

This argument was rejected by the Court.  It found that the only parties to the mortgage were CEG and Runtong and, at the relevant time, CEG obtained a benefit by reason of additional security.  CEG was the only party to the transaction that received a benefit and it therefore was expected that a reasonable person in Runtong’s circumstances would not have granted the mortgage.

This decision acts as a warning to secured lenders who take cross-securities from related entities.  These securities may be void if the mortgagor enters liquidation within 4 years and the other criteria are met.

This may be the case even if the mortgagor is not insolvent at the time of granting the cross-security; and even if the liquidation is a solvent liquidation: Aviation 3030 Pty Ltd (in liq) v Lao [2022] FCA 458.

CEG have filed an appeal against the judgment and the matter is to be considered by the Full Court.

Oracle Insolvency Services wish to thank our senior counsel Garry Bigmore KC and our solicitor/junior counsel Arnie Narayan of Travancore Legal & Advisory.  Thanks also to Heather Collins and the team at Omni Bridgeway.