26 Mar Case study – When is a loan from a company really a loan?
A common assumption is that all funds withdrawn from a company by an officeholder, or associate, for personal use would be treated by a future liquidator as a loan, recoverable upon demand.
Another common assumption is that a debit director loan, recorded in the books of the company, would be low-hanging fruit for a future liquidator, and the director would be required to pay-up upon demand. When we scratch the surface, it gets a little more complex.
Case 1 – RE Pacific Hardware Brokers (QLD) Pty Ltd SC (QLD) 1997
In the case of RE Pacific Hardware Brokers (Qld) Pty Ltd SC (Qld) 1997, the liquidator sought to recover $30,000 from the sole director of Hardware Brokers (Qld) Pty Ltd which was used to buy a diamond engagement ring for the then-girlfriend of the director (she went on to become his wife for those romantics among us, and this also becomes relevant – so the romantically-jaded among us should still pay attention). The liquidator also sought to recover furniture recorded in the company records as ‘office furniture’, although it was apparent it was being used by the director personally.
The director claimed the $30,000 used to buy a diamond engagement ring (part cash and part Bartercard dollars) was essentially a loan to him by the company (this could have been reasonable enough for the liquidator to accept). If this were successfully argued however, it may have prevented the liquidator trying to recover the diamond ring under voidable provisions within the Corps Act.
The Judge concluded that there was nothing in evidence that satisfied him that there was contemporaneous intention at the time of purchase of the ring that the funds were a loan to the director – so this leaves the ring in play (for now).
The Court then considered whether the Liquidator could recover the diamond ring from the director’s wife. It was concluded that as she was not a party to the transaction, had no knowledge it was purchased with company funds, and that it became her property at the time she became the director’s wife (up until that point an engagement ring is a gift conditional on marriage – Kais v Turvey (1994) 11 WAR 357). The liquidator was not able to seek the return of the ring under s588FF of the Corps Act.
But what of the $30,000 of company funds used to buy it? The director claimed these funds were loaned to him by the company which the Court disagreed with. So the funds could not simply be recovered as any asset of the company pursuant to s483 of the Corps Act. The liquidator was successful in arguing the funds amounted to a voidable transaction and were recoverable by the liquidator pursuant to s588FF.
The liquidator was also seeking the recovery of furniture, acquired for $2,519. The furniture was purchased with a company cheque which contained “office furniture” on the butt. The director conceded that he had intended to obtain a tax advantage by arranging the transaction in that manner but that the furniture was never situated at the company’s premises, but instead his residence.
The Judge was satisfied that the furniture could be recovered pursuant to s483 of the Corps Act as an asset of the company. He noted that the books of the company show it was paid for with company funds and that it was described as office furniture. Where such property is in the hands of an officer of the company, the court may direct that the property be placed into the custody of the liquidator even if there is some contention by the officer as to its ownership.
Take-away points thus far:
For a loan to exist, there needs to be some evidence of a ‘contemporaneous intention’ that a loan account ought to result at the time that the transaction/s takes place.
- A party that acquires (or receives – as far as a gift is concerned) an asset in good faith from a company that is later wound up, but that is not a party to the transaction as contemplated by s588FG, may escape the reach of the voidable recovery provisions within the Corps Act.
- A court may direct that property be placed into the custody of the liquidator where the property has been purchased with company funds, is described in the company’s records as a company asset, and is in the hands of an officer of the company even if there is some contention by the officer as to its ownership.
- Love does exist.
Now, onto that other, pretty reasonable, assumption that a debit director loan, recorded in the books of a company, would be recoverable by a liquidator of that company; or alternatively that a credit director loan recorded in the company books, may be recoverable by a bankruptcy trustee appointed to the director.
Case 2 – Michell v Onroad Offroad Pty Ltd 
The recent case of Michell v Onroad Offroad Pty Ltd  VSC 648 considered the latter, and I believe the case would also apply to the former.
By way of a recklessly-speedy summation of the case:
- Ms Cheryl Hill was declared bankrupt on 22 April 2014;
- The trustee in bankruptcy sought to recover $1,292,005.88 from Onroad Offroad Pty Ltd, which sat in the books of the company as a ‘Loan to Director’;
- Ms Hill had been the sole director of the company from incorporation to early 2014, when her husband took over the role;
- The ‘Loan to Director’ was structured and established by the company’s former accountant shortly after it was incorporated. The account recorded a series of debit and credit transactions, although no details were held as to how or why it was initially created;
- No written instrument or documentation detailing a loan agreement was held, although the tax returns and financials had been signed off by the director each year.
The trustee made an application to court to recover the loan from Onroad Offroad. The trustee sought to rely on s1305(1) of the Corps Act which states that a book kept by a body corporate under a requirement of this Act is admissible in evidence in any proceeding and is prima facie evidence of any matter stated or recorded in the book.
The Judge found s1305(1) to be of limited use to the trustee and found the trustee was rather required to prove the existence of an underlying loan agreement between Ms Hill and the company, and of the advance/s thereunder. The Judge found the accounting entries relied upon by the trustee were insufficient proof of the underlying loan or advance to the company. Instead, the Judge found, whether there is a loan agreement depends on the objective intention of the company and Ms Hill at the time the agreement was alleged to have formed.
So, to tie this back to the ‘take-away points’ from above, another court in a separate state, has found that for a loan to exist, there must be objective intention, or contemporaneous intention as it was previously put, between the parties. It would appear, from the Onroad Offroad case, that the bar is relatively high to prove that intention, given Ms Hill has signed off on all tax returns and financials of the company containing the ‘Loan to Director’ account, and this failed to prove intention in that case. It appears to me that nothing short of bank statements showing funds advanced to the company would have sufficed, which in a world of weird and wonderful accounting techniques that often result in loan accounts for less logical and transparent reasons, may not always be possible.
As a final little nugget for the trustee to swallow before he has to sweat on cost orders, the Judge agreed with Onroad Offroad that the claim by the trustee, if it were allowed, was statute barred after six years from the creation of the loan in 1998.
The bar may have just got very high for the poor insolvency practitioners to recover such a ‘loan account’.