In Short
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Definition: An uncommercial transaction occurs when a company engages in an agreement that offers minimal benefit to itself but significant advantage to another party, such as a director or related entity, especially as the company approaches insolvency.
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Key Elements: Such transactions typically happen when the company is insolvent or becomes so due to the deal, provides no commercial benefit, and a reasonable person would not have agreed to the terms under similar circumstances.
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Consequences: Engaging in uncommercial transactions can lead to the reversal of the transaction, personal liability for directors, civil penalties, and potential criminal charges.
Tips for Businesses
Ensure all transactions, especially during fundraising, are commercially reasonable and beneficial to the company. Avoid agreements that disproportionately favour certain parties over others, as they may be deemed uncommercial. Consult with legal professionals to navigate complex financial arrangements and uphold fiduciary duties.
Directors’ duties extend beyond serving the company’s and its shareholders’ interests. As a company approaches insolvency, it must also consider and protect the interests of creditors. An uncommercial transaction is an agreement or deal entered into by a company that provides little to no benefit to the company itself, while potentially providing significant benefit to another party such as a director or a related group entity. As a company approaches insolvency, directors must consider the interests of creditors, not just shareholders. Entering into uncommercial transactions that deplete the assets available to pay the company’s creditors can breach these duties. This article guides you through the elements, examples and consequences of utilising uncommercial transactions.
Elements of Uncommercial Transactions
The key elements that define an uncommercial transaction are:
- the transaction occurred when the company was insolvent or became insolvent due to the transaction;
- the company received no commercial benefit from the transaction, and the detriment outweighed any benefit received; and
- given the company’s circumstances, a reasonable person would not have entered the transaction.
Examples of Non-commercial Transactions During Fundraising
In the context of capital raising, some examples of transactions that could potentially be considered uncommercial include:
- Issuing shares at a significant discount: If a company issues new shares at a price significantly below market value, it may be an uncommercial transaction. This applies if there is no commercial justification for the discounted price. Essentially, it dilutes the existing shareholders’ interests without providing adequate value to the company.
- Granting excessive rights or preferences: If a company grants new investors excessive rights or preferences, it may be an uncommercial transaction. This is especially true if these rights are disproportionate to their investment and harm existing shareholders.
- Raising capital on unfavourable terms: If a company raises capital on excessively unfavourable terms, it may be an uncommercial transaction. This applies if the terms include high interest rates, restrictive covenants, or excessive fees. A reasonable person would not agree to such terms given the company’s circumstances.
- Issuing convertible securities at a deep discount: If a company issues convertible securities with a conversion price far below market value, it may be an uncommercial transaction. This can dilute existing shareholders without adequate compensation.
- Raising capital from related parties on favourable terms: If a company raises capital from related parties (e.g., directors, shareholders) on terms that are overly favourable to the related party and detrimental to the company, it could be considered an uncommercial transaction.
- Entering into capital-raising transactions with insolvent parties: If a company raises capital from an insolvent investor, it may be an uncommercial transaction. This applies if the terms are not commercially reasonable or beneficial to the company.
Possible consequences of uncommercial transactions
The consequences of uncommercial transactions can be severe if identified, such as:
- the transaction could be unwound and assets/money returned to (or by) the company;
- directors could face personal liability to compensate creditors;
- directors could face civil penalties of over a million dollars;
- directors could face potential criminal charges for dishonest intent like fraud; and
- creditors can claim compensation from the directors, the company or other related parties.
The key is that as insolvency approaches, the interests of directors and the company can diverge from creditors. Any transactions appearing to prioritise interests over those of creditors will be scrutinised. Professional advice is crucial to ensure compliance.
Before buying a business, it is important to undertake due diligence, to verify the information supplied by the seller. This guide will walk you through the due diligence process.
Key Takeaways
While capital raising is often needed for a struggling company, the terms must be commercially reasonable from the company’s perspective. There’s a fine line between negotiating terms with new investors that allow the company to stay afloat without treating existing investors unfavourably versus entering into an uncommercial transaction that unreasonably benefits the new investors at the expense of existing stakeholders.
Prioritising personal interests or improperly benefiting third parties over creditors can have disastrous financial and legal consequences for those involved. If in doubt, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
What are the key elements of an uncommercial transaction?
For a transaction to be considered uncommercial, it must occur when the company is insolvent or becomes insolvent due to the transaction. The company must receive no commercial benefit, and the detriment outweighs any benefit. A reasonable person would not have entered into the transaction given the company’s circumstances, especially if it’s a voidable transaction.
What are some examples of uncommercial transactions in fundraising?
Examples include issuing shares at a significant discount, granting excessive rights to investors, or raising capital on unfavourable terms, such as high interest rates or restrictive covenants. These could be considered voidable transactions if they disproportionately benefit investors at the expense of an insolvent company or its creditors.
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