When a company enters liquidation, the conduct of its directors and the transactions they authorised come under scrutiny. One of the most significant tools available to liquidators is the ability to unwind an unreasonable director-related transaction under section 588FDA of the Corporations Act 2001 (Cth).

For directors facing insolvency or creditors seeking to recover debts, understanding the mechanics of these provisions is critical. Unlike other areas of insolvency law, unreasonable director-related transactions (UDRTs) do not rely on the company being insolvent at the time the transaction took place. This unique characteristic gives liquidators a powerful retrospective reach to claw back assets for the benefit of creditors.

Where Unreasonable Director-Related Transactions Fit in the Voidable Transaction Regime

The Corporations Act gives liquidators broad powers to challenge certain transactions made before liquidation. These are known as voidable transactions, and include:

• unfair preferences
• uncommercial transactions
• insolvent transactions
• unfair loans
• creditor-defeating dispositions
• unreasonable director-related transactions

Each of these provisions serves a specific purpose in the voidable transaction regime. While unfair preferences stop creditors from jumping the queue, and uncommercial transactions stop assets from being sold for less than market value, unreasonable director-related transactions are specifically targeted at preventing company assets from being diverted to directors or their associates.

What makes unreasonable director-related transactions stand apart is their reach. Unlike most other voidable transactions, the liquidator does not need to establish insolvency when the transaction occurred. This makes UDRTs one of the most forceful claw-back mechanisms in insolvency.

This legislative design, introduced via the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004, was clarified in the explanatory memorandum to ensure that directors could not strip assets from a company regardless of its financial health at that specific moment.

What is an Unreasonable Director-Related Transaction

To understand how a liquidator pursues these claims, we must look at the specific definition under s 588FDA of the Corporations Act 2001. A transaction will be caught by this section if it meets specific criteria regarding the parties involved, the nature of the disposition, and the reasonableness of the deal.

A transaction may be an unreasonable director-related transaction if:

1. The company enters into a transaction

This covers almost anything: payment, transfers of property, issuing shares, granting securities, forgiving debts, or taking on obligations such as mortgages or guarantees.

The definition of “transaction” in this context is broad. It includes a conveyance, transfer, or other disposition of property of the company. It also extends to the incurring of an obligation by the company. It is important to note that the transaction can be completed or incomplete, and it may include a series of related dealings.

2. The transaction is to, or for the benefit of, a director or “close associate”

This covers almost anything: payment, transfers of property, issuing shares, granting securities, forgiving debts, or taking on obligations such as mortgages or guarantees.

Identifying the beneficiary is a key step. The legislation applies to a director of the company, a close associate of a director, or a person on whose behalf, or for whose benefit, a director or close associate enters into the transaction.

A close associate of a director is defined strictly. Under the Act, unless a contrary intention appears, this includes a relative of the director or the director’s spouse (including a de facto spouse). The definition of relative extends to parents, children, and siblings, and even to a remoter issue (grandchildren) or remoter ancestor. It effectively captures family members and entities where a director has a material interest.

Furthermore, the provisions catch indirect benefits. For example, if a company pays a debt owed by a director’s private family trust, this may be deemed to be for the benefit of a director.

3. A reasonable person in the company’s circumstances would not have entered into the transaction

This is the core of the provision, also known as the reasonable person test.

The court assesses this by looking at:

• the benefit (if any) to the company
• the detriment to the company
• the respective benefits to other parties
• all relevant surrounding circumstances

The test is objective. If a reasonable company would not have agreed to the transaction on commercial terms, the transaction is vulnerable.

When applying the reasonable person test, the court does not look at what the specific director thought was reasonable. Instead, it asks what a reasonable person in the company’s position would have done. The court noted in various judgments that this involves weighing the benefit provided to the company against the detriment it suffered.

If the transaction caused a detriment to the company (such as the loss of an asset or cash) and resulted in little or no benefit to the company, but a significant benefit to a director, it will likely be deemed unreasonable.

The Role of Reasonableness and the “Company’s Circumstances”

To determine if such transactions are unreasonable, the court conducts a balancing exercise. They will examine whether there were reasonable grounds for the company to enter the deal.

Specifically, the court considers:

• The Benefit: Did the company receive fair value? Was the benefit of the transaction clearly documented?
• The Detriment: Did the transaction deplete the company’s assets? Did it increase the company’s liabilities?
• The Benefits to the Director: Did the director or a close associate receive a windfall at the expense of the company?

The relevant matter is whether the transaction was commercial. Ideally, a validly appointed director acting in accordance with their duties would not authorise a transaction that offers no value to the entity they serve. If a transaction is explicable only by reference to the director’s personal relationship with the company, rather than sound business judgment, it is at risk.

The Four-Year Look-Back Period and the “Relation Back Day”

A liquidator can review and challenge transactions going back four years from the “relation back day”. This captures a wide window of time, including periods where the company was not showing obvious signs of financial distress.

The relation back day is generally the date the application for winding up was filed or the date administrators were appointed. This lengthy retrospective period means that directors cannot simply wait for a short period to expire to avoid scrutiny.

Because insolvency is irrelevant, transactions that seemed harmless at the time can become problematic later. This is why rigorous governance and proper documentation are so important.

Why Unreasonable Director-Related Transactions Are More Powerful Than Other Voidable Transactions

Several features make unreasonable director-related transactions uniquely risky:

No insolvency requirement

The liquidator does not need to show the company was insolvent when the transaction occurred widening the number of transactions that can be challenged.

For most other claw-back provisions, such as unfair preferences (s 588FA) or uncommercial transactions (s 588FB), the liquidator must prove the company was insolvent at the time or became insolvent because of the transaction. For section 588FDA, to avoid doubt, the legislation removes this hurdle. Even if the company was fully solvent, if the transaction was unreasonable and benefited a director, it is voidable.

Limited defences

Common defences available in other voidable transaction claims (e.g. good faith, valuable consideration) do not generally apply.

Under s 588FG of the Corporations Act, defences are available to parties who received a benefit in good faith and without suspicion of insolvency. However, these defences are strictly limited regarding 588FDA claims. Because the transaction involves a person closely connected to the company (a director or associate of a director), the law presumes they should have known the transaction was not in the company’s best interests.

Applies to indirect benefits

A transaction may still be “for the benefit of” a director even if the benefit is indirect or flows through another entity.

This captures complex structures where a director acts on a person’s instructions to channel funds to a related entity.

Common Examples of Unreasonable Director-Related Transactions

Real-world examples often include:

• large bonuses or payments to directors before liquidation
• transferring company property to a director or related entity for less than market value
• granting director-related parties securities, mortgages or guarantees that erode the asset pool for other creditors
• forgiving debts owed by directors or related entities
• paying personal expenses of directors through the company

Recent court decisions confirm that even sophisticated arrangements such as granting a mortgage that secures a director’s separate liability may be voidable if they lack a commercial explanation.

Another common scenario involves an alternate director or a person acting in a position of influence (a de facto or shadow director) directing the company to pay family members excessive wages for work not performed.

What This Means for Directors

Directors must exercise caution whenever they receive payments or benefits from the company, or when the company enters transactions involving parties in the director-related sphere. Key risks include:

• personal exposure if a liquidator later seeks recovery
• reputational damage
• the possibility of follow-on claims (e.g. breach of duties, insolvent trading)

If a transaction is found to be unreasonable, the court can make various orders, including requiring the director to pay back the money, transfer property back to the company, or discharge a debt.

Directors should ensure each transaction:

• has a clear commercial justification
• is properly documented
• is approved in accordance with governance processes
• provides demonstrable benefit to the company (not just to the individual)
• is reviewed by a person in the company’s governance team (e.g., non-conflicted board members).

A lack of paperwork is often fatal, so liquidators will assume the worst if the commercial basis is not evident.

Directors should ask: “Is it expected that a reasonable person would do this?” If the answer is no, or if there is doubt, do not proceed.

What This Means for Creditors

For creditors, UDRTs can be beneficial. They allow liquidators to recover assets that were improperly depleted, increasing the pool available for distribution. Creditors should be alert to warning signs, such as:

• related-party loans or repayments
• asset transfers to directors or their companies
• sudden increases in director remuneration
• new securities granted to director-related entities shortly before collapse

If these issues arise, creditors should raise concerns early with the liquidator.

Final Thoughts

Unreasonable director-related transactions are a powerful mechanism allowing liquidators to unwind transactions that unfairly benefit directors. Their broad scope, four-year look-back period and lack of an insolvency requirement mean that directors must exercise ongoing discipline, transparency and commercial justification in every transaction that involves them.

If your company is facing financial pressure or you are concerned about the validity of past payments or transfers, obtaining early advice can avoid significant recovery actions later.

Contact Rose Litigation Lawyers today to connect with expert advice from our expert commercial law team.

The content of this publication is intended to provide a summary and commentary only. It is not intended to be comprehensive, nor does it constitute legal advice and has been prepared based on applicable legislation and case authority at the date of publication. You should seek legal advice on specific circumstances before taking any action.