Certainty For Lenders

Two recent events give some comfort and certainty to secured lenders.

The first is a decision by the NSW Court of Appeal clarifying the position of lenders and the conditions they can impose on their debtors without the risk of becoming ‘shadow’ directors of their customers.

Secondly, the announcement in the Federal Budget of proposed changes to the GST law in relation to property in possession of a mortgagee will overcome cost and compliance issues caused by an apparent overlap in the current legislation.

The Court’s guidance on ‘shadow’ directorship

Last month’s appeal decision in Buzzle Operations Pty Ltd (in liq)  -v-  Apple Computer Australia Pty Ltd [2011] NSWCA 109, concerned an insolvent trading claim by a company’s liquidator against a secured lender (Apple) and Apple’s finance director on the basis that they were ‘shadow’ directors of their debtor (Buzzle). A ‘shadow’ director is a person who, whilst not formally appointed as a director, is nonetheless deemed a director by definition under the Corporations Act if ‘the directors of the company … are accustomed to act in accordance with the person’s instructions or wishes.’ 

There is legal precedent establishing that a lender (or its representative) can be considered in certain circumstances to be a ‘shadow’ director of a debtor company. The decision in the Buzzle case is important because it provides appellate Court commentary and guidance on the elements required to establish ‘shadow’ directorship. 

The Court dismissed the appeal and outlined some basic principles to be satisfied before ‘shadow’ directorship is established. From the perspective of a secured lender, the most relevant principle is:

If a person has a genuine interest of his or her or its own in giving advice to the board, such as a bank or mortgagee, the mere fact that the board will tend to take that advice to preserve it from the mortgagee’s wrath will not make the mortgagee, etc a shadow director.

The Court noted that this is particularly so where the mortgagee’s actions are supported by contractual rights in the mortgage documents.

The Court’s comments potentially alleviate some concerns for lenders where they attempt to protect their interests by the imposition of specific conditions or stringent reporting requirements on the mortgagor. The risk of being deemed a ‘shadow’ director in such circumstances is now somewhat reduced however it appears that this may still be an area that will lend itself to future litigation. In this regard it may well be worth secured creditors making a formal appointment in some circumstances to further alleviate any concerns that they may have in relation to shadow directorships.

The proposed Budget changes to GST legislation

The announcement in the Budget of changes to the GST treatment of property in the possession of a mortgagee is a codification of the ATO’s interpretative approach to the problem of an overlap between Division 105 and Division 58 of the GST Act. 

The problem arose when Division 58 was introduced into the GST Act in late 2009 to counter a Court decision on the liability of a liquidator for GST. Division 58 concerns the GST obligations of a ‘representative’ of an incapacitated entity. Included in the definition of ‘representative’ in the GST Act is a ‘controller’ which in turn includes a mortgagee in possession of property of the company. The GST obligations of a mortgagee in possession are already provided for in Division 105 of the GST Act – hence the overlap which creates uncertainty for secured lenders.

The issue required clarification because the two Divisions contain differences in relation to registration and reporting requirements. Under Division 105, a mortgagee reports GST liabilities on sale of a mortgagor’s property under a single registration whereas under Division 58 a representative is required to register separately for each incapacitated entity. Importantly too, Division 105 provides that a supply of a mortgagor’s property by a mortgagee is not a taxable supply in certain circumstances. No such exclusion is provided by Division 58.

The Budget announcement means that the GST Act will be amended to provide that Division 105 operates to exclude Division 58 where a mortgagee in possession sells property of a corporation.

The proposed changes will give increased certainty to secured lenders and reduce compliance costs particularly for entities in the mortgage lending sector. If implemented, the amendments will have effect from 1 July 2012.

For specialist advice on all insolvency matters contact John Vouris and Brad Tonks in Sydney on 02 8346 6000 or via jvouris@lawlerpartners.com.au, btonks@lawlerpartners.com.au or Ray Tolcher in Newcastle on 02 4962 2294 or via rtolcher@lawlerpartners.com.au