Court of appeal “appeased” re section 588FDA director-related transaction

In the case of Changela v Dracoma Pty Ltd [2025] NSWCA 186, the New South Wales Court of Appeal considered the question of what constitutes an unreasonable director-related transaction pursuant to section 588FDA of the Corporations Act 2001 (Cth).

The case involved separate loans made by two shadow directors of Changela Exports Pty Ltd (a chickpea export company) in July 2017 which were repaid in September 2017.  Changela Exports Pty Ltd was placed into liquidation on 23 December 2020.  It was not in issue that the repayments were made at a time when the company was solvent, and that the repayments did not cause the company to become insolvent.

The Court at first instance found that the repayments were unreasonable on the basis that the funds should reasonably have been left in the company in preparation for the purchase of the next season’s crop.  This finding and the Court’s reasoning were challenged on appeal.

Background

Changela Exports Pty Ltd (the Company) operated a business exporting chickpeas from Australia to India.  It had a relatively short trading life and only operated its export business from September 2016 until early 2018 when it ceased trading.

The directors and shareholders of the Company were initially Sweta Changela and “Radhika” who were replaced by “Grishkumar” and “Jayana” in 2019, but none of these four people played any role in administering the Company’s affairs.  Instead, the Company was in fact run by Prashant Changela (Sweta Changela’s husband) and his business associate Dr Vijay Pandya.  Prashant Changela admitted that he was a shadow director of the Company and, after more than a day of cross examination at trial, so did Dr Pandya.

Dracoma Pty Ltd (Dracoma) operates a business growing chickpeas on several farms located in the Central West and Orana regions of New South Wales.  The sole director and shareholder of Dracoma was and is Alex Wheeler.

Mr Wheeler’s long-term doctor was Dr Pandya.  In September 2016, Dr Pandya introduced Mr Wheeler to Prashant Changela.  Shortly after this meeting, the Company agreed to purchase Dracoma’s 2016 crop of chickpeas (the 2016 Crop) for approximately $1.5m.  The 2016 Crop was delivered by Dracoma between November 2016 and February 2017 and was paid for in full by the Company on 12 April 2017.

Subsequently, on 19 July 2017, Sweta and Prashant Changela transferred $250,000 to the Company, and Vijay Pandya Pty Limited (Dr Pandya’s company) (VPPL) also transferred $250,000 to the Company.  The Court at first instance found that these advances were loans that were repayable on demand.  This finding was not challenged on appeal.

Then, on 20 September 2017, the Company transferred $250,000 back to each of Prashant Changela and Dr Pandya/VPPL (the Impugned Payments).  Importantly, on that same day, Prashant sent an email to Dr Pandya (and others) saying (amongst other things) that he had “transferred back $250,000 to you and me” and that “by end of this week we will have clear picture on final [profit] for the last season as we are completely done with it”.

It was not in issue that the Company was not insolvent at the time of the Impugned Payments, and that the Impugned Payments did not cause the Company to become insolvent.

Prashant Changela entered into discussions with Alex Wheeler in October 2017 about purchasing Dracoma’s 2017 crop of chickpeas (the 2017 Crop), and the Company entered into an agreement to purchase the 2017 Crop for approximately $1.8m at some time in late 2017 (the Company’s general ledger contained an entry dated 20 December 2017 in respect of this purchase).  It appears that given the cash position of the Company at the time, the only means available to the Company to pay for the 2017 Crop was the proceeds of any on sale of that crop.

The following then occurred:

• the Company sold most of the 2017 Crop to an Indian company named Vijay Pulses Pvt Limited (Vijay Pulses) for approximately $2m;
• however, during the period of the transaction, the Indian government imposed 30% and then 40% tariffs on all chickpeas imported into India;
• the chickpeas destined for Vijay Pulses were shipped in late December 2017 and by 3 January 2018 the Company had incurred total packing and shipping costs (including tariffs) of $370,000;
• this resulted in a loss to the Company of around $176,000 on the headline transaction value;
• the Company was unable to recoup any funds by selling the remainder of the 2017 Crop; and
• Vijay Pulses ended up only making payments to the Company of just over $1.2m, some $800,000 less than the contract price.

The Company ceased to trade following the Vijay Pulses transaction and was placed into liquidation on 23 December 2020.

In September 2022, Dracoma entered into a deed of assignment with the liquidator of the Company and acquired any claims available to the Company or the liquidator against any directors of the Company.

Dracoma then commenced proceedings against Prashant and Sweta Changela and against VPPL in respect of a range of voidable transactions including the Impugned Payments.

The primary judge held that the Impugned Payments constituted unreasonable director-related transactions contrary to section 588FDA(1) of the Corporations Act 2001 (Cth) (Act) as the Company had formed the intention to purchase the 2017 Crop prior to those payments and the payments diminished the liquid funds available to purchase the 2017 Crop without consideration of the effect on the Company or its future creditors.

Prashant and Sweta Changela and VPPL then appealed to the NSW Court of Appeal.

The legislation

A transaction will be an unreasonable director-related transaction under section 588FDA of the Act:

• if there is a transaction (s 588FDA(1)(a)); and
• that transaction is between a company and a director of that company (including if the transaction is for that director’s benefit or if the transaction is with a relative of the director) (s 588FDA(1)(b)); and
• it may be expected that a reasonable person in the company’s circumstances would not have entered into the transaction (s 588FDA(1)(c)).

The test of reasonableness in sub-paragraph (c) is an objective one, and requires an assessment of what a reasonable person in the company’s circumstances may be expected not to do.

In assessing reasonableness for the purpose of section 588FDA(1)(c), the Court must have regard to the following:

• the benefits to a company of entering into the transaction;
• the detriment to a company of entering into the transaction;
• the respective benefits to other parties to the transaction of entering into it; and
• any other relevant matter.

Judgment

The decision of the Court of Appeal was given by Bell CJ (with Leeming and McHugh JJA agreeing).

Bell CJ considered the authorities in relation to section 588FDA and helpfully noted in particular the following points of principle:

• the “company’s circumstances” encompass all relevant matters, starting with its status as a company and what from that; its controllers, shareholders, business and other activities; and the facts and circumstances of, and surrounding, the transaction.  What constitutes “any other relevant matter” depends on the facts and circumstances of the particular case;
• the question of “what was wrong about the conduct as manifested by the transaction” is to be answered at the time the transaction occurred, but prior facts or events or foreseeable future consequences should be considered, especially considering that section 588FDA is an anti-avoidance provision;
• the prevailing view is that a broad interpretation of “benefit” to the director should be applied, and should capture both direct and indirect benefits; and
• the detriment to the company should be a commercial detriment but this does not confine detriment to something that can necessarily be measured in money terms.

Having considered the authorities and the facts of the case, the Court of Appeal ultimately found that:

• the reasonableness criterion in section 588FDA(1)(c) of the Act was not satisfied; and
• the primary judge erred in finding that the impugned payments were unreasonable director-related transactions for the purpose of section 588FDA of the Act.

The Court of Appeal held that:

• a reasonable person in the position of the Company would be expected to pay their debts when they fall due where this would not prefer the lenders over any other creditors and where the Company was not insolvent and would not become insolvent as a result of the payments;
• the Impugned Payments did not result in any net commercial detriment to the Company as they merely extinguished a corresponding liability;
• the benefit received by the appellants was the repayment of loans in accordance with their terms and consistent with the Company’s past practice.  Such a benefit does not resemble those typically giving rise to a breach of section 588FDA; and
• the primary judge’s reliance on the Company’s “prior intention” to purchase the 2017 Crop was overstated given that there was no agreement in place at the time of the Impugned Payments, there was some uncertainty surrounding the export market at the time of the payments, and it was open to Dracoma to satisfy itself of the Company’s financial position at the time of contracting for the sale of the 2017 Crop.

Lavan comment

This decision provides a useful summary of the principles for assessing an unreasonable director-related transaction for the purposes of section 588FDA, as well as an illustration of how the application of these principles to the facts of a case can be complex.

Directors should have careful regard to this case when considering whether to cause their company to enter into a transaction that might result in them receiving a direct or indirect benefit.  Similarly, liquidators will be assisted by this decision when reviewing previous director-related transactions.

If you have any questions about this decision, or in relation to any director-related payments or transactions, the experienced Lavan team is here to help.

Many thanks to Kelsey Quick for her assistance in the preparation of this publication.

Disclaimer

The information contained in this publication does not constitute legal advice and should not be relied upon as such. You should seek legal advice in relation to any particular matter you may have before relying or acting on this information. The Lavan team are here to assist.