Employee entitlements and secured creditors

July 2014

Restructuring and Insolvency Insight: A bump up for the priority of employee entitlements over secured creditors

A decision in the Federal Court of Australia on 30 June 2014 confirms that:

  • Where a receiver makes payment of employee entitlements under section 433 of the Corporations Act 2001 (Cth), the secured creditor will be entitled to be subrogated to the rights of the employee priority creditors (to whom the receivers make payments) in any winding up of the company; and
  • Where a receivership is followed by a winding up of a company, the deeming provisions in section 558(1) will apply to vary the priorities of employee entitlements under section 433.

Subrogation following section 433 payments

It is well understood that a secured creditor (or someone else) who makes a payment of various employee entitlements will be entitled to be subrogated to the position of those employees in a winding up of the company under section 560. Where a liquidation results in recoveries from unfair preferences this can represent an alternative recovery avenue for preinsolvency advances made by secured creditors on account of employee entitlements.

However, where a receiver makes payments in accordance with the obligation under section 433, it was previously unclear whether the secured creditor would have any entitlement to be subrogated in a similar way – where proceeds from assets secured to the secured creditor are paid in priority to employees.

The position was clarified by White J in Divitkos, in the matter of ExDVD Pty Ltd (in liquidation) [2014] FCA 696. White J has confirmed that the secured creditor is entitled to be subrogated to the position of the employees and to prove in the winding up for any shortfall of its secured debt.

White J explains that the right of subrogation arises in equity. The explanation given is as follows:

“Receivers exercise their duties in the interests of their appointers, as well as in the interests of the company to which they are appointed. Rather than intending the loss of a security, their function is to preserve and realise the security. It would be inappropriate to impute an intention by them to forego that security when they make payments required by law. For the unsecured creditors or for the company itself to seek to have the benefit of the compulsory payment would, in my opinion, be both opportunistic and unconscionable.”
 

The section 558 deeming provision

There is now further authority about the impact of section 558(1) (which deems employment contracts to be terminated on a company’s winding up and all amounts to be due and payable for the purposes of the priority provisions in section 556) when calculating the quantum of employee entitlements afforded priority by section 433.

White J considers the line of authorities commencing with the decision of Finkelstein J in McEvoy v Incat Tasmania Pty Ltd (2003) 130 FCR 501 and followed by the Federal Court in Vickers v Challenge Australia Dairy Pty Ltd (2011) 190 FCR 569 albeit “not without some hesitation”. Those cases decided that section 558 had no application to the priority of employee entitlements under section 433 (at least where a receivership was not followed by a winding up). However, White J has determined that where a receivership is followed by a winding up, section 558 has application to vary the priorities established by section 433.

The circumstances in ExDVD were also different to those before Master Sanderson of the WA Supreme Court in Great Southern Limited (receivers and managers appointed) (in liq); ex parte Thackray [2012] WASC59. In ExDVD, receivers were appointed and their appointment was followed by the appointment of voluntary administrators who would become liquidators.

For practitioners who now have the benefit of the consistent decisions in Great Southern and ExDVD, there appears to be no difference in the employee entitlements which are afforded priority under section 433 where there is both a receivership and a winding up of the company, no matter in which order they commence.

However as White J points out, the line of authority commencing with McEvoy v Incat Tasmania confirms that a different result does emerge where there is a receivership and no liquidation. The practical effect is that the priority employee entitlements in section 556 are not deemed to be calculated as if the employees were terminated on the “relevant date” where that expression appears in section 556. Accordingly, amounts payable as a priority under section 556(1)(e), (f) and (g) will be lower through section 433 if there is no winding up concurrent with a receivership.

White J also makes the observation that in relation to retrenchment payments (which are afforded priority under section 556(1)(h)), common sense suggests that these are only payable as a priority under section 433 where the retrenchment happens over the course of the receivers appointment – if it happens after the conclusion of the receivership, there is no obligation for the receiver to pay the retrenchment entitlements in priority to the secured creditor.
 

Scope for reform

In her recent publication The Protection of Employee Entitlements in Insolvency an Australian Perspective, Associate Professor Helen Anderson notes this divergence and says: “The policy rationale for these different policy regimes in [sic] unclear, and the government should consider reforming this anomaly.” Whilst the decision of White J will serve to align the divergence between sections 433 and 561, there remains a substantial divergence by reason of the line of authority from McEvoy v Incat Tasmania. The decision in ExDVD highlights the need for government to consider statutory alignment of sections 433 and 561.


Impact of this insight

Secured creditors will want to be careful when deciding whether to make a joint appointment of receivers and voluntary administrators – if the voluntary administration results in a winding up then the scope of priority employee entitlements under section 433 will widen.

Receivers should be sure to retain records of payments they make under section 433 and advise their appointor to prove for any shortfall using their subrogated position in a winding up.