Business sales prior to liquidation - a cautionary tale

25th October, 2019

Business sales prior to liquidation - a cautionary tale

The recent Federal Court of Australia decision of ACN 093 117 232 Pty Ltd (in liq) v Intelara Engineering Consultants Pty Ltd (in liq) [2019] FCA 1489 describes a pre-insolvency sale of a business to a related entity that came unstuck as an uncommercial transaction voided pursuant to Section 588FE of the Corporations Act 2001.

What makes this case most intriguing is that the directors of the two companies involved in the transaction had received pre-insolvency consultancy advice from two advisers (neither being registered liquidators) giving a positive recommendation to the transaction.

In short, the transition of the business from Oldco to Newco was paid for by Newco assuming selected employee entitlements, which is not uncommon in traditional Phoenix transactions. The distinguishing feature here, though, was that the assets that remained to be sold in Oldco after the sale were directly available to meet Oldco’s secured creditor, without the deduction of the transferred priority employee entitlements.

The subsequent failure of Newco 44 days later exposed the transaction’s underlying purpose as being a means by which Oldco’s debt to the secured creditor could be repaid to the maximum extent (and relieving the Directors of personal guarantees), hoping that the transferred employee entitlements would be picked up by the Fair Entitlements Guarantee Scheme in Newco.  

Newco’s lack of solvency at the time of the assumption of the employee entitlement liability diminished the value that could be attributed to the consideration, enabling the transaction to be made void.

We are not saying that the assumption of employee entitlements cannot be considered as part of valuable consideration for a sale, but not recognising all risks associated with the transaction exposed the directors to the transaction being unwound as it was.

This case highlights the risk of structuring sales of businesses prior to liquidation without competent and reliable advice being first obtained.  Proper restructuring of a business at or around a time of insolvency requires a broad consideration of business value, assessment of future viability, identifying disparate stakeholder interests and knowing the priority interests of different classes of creditors.  This is a skill developed through years of experience and training and should be considered by directors when choosing a professional to advise the path of their business in such difficult times.

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