Comply strictly with legislation or lose priority in liquidation

When a company is placed into liquidation, the company’s available funds are paid to general unsecured creditors on a pro rata basis by way of a dividend payment.  However, certain classes of creditors are given priority in the payment of dividends, including employees who are owed wages and other employment entitlements by the company.

What is the position if a person advances money to a company, after it has been placed into external administration, to allow the company to pay wages or other entitlements to employees?

Section 560 of the Corporations Act

Section 560 of the Corporations Act (“the Act”) provides that any person who makes such an advance to a company is to be subrogated to the position of the employees in respect of the payment for the purposes of participating in a dividend.  This means the person who advances the money is entitled to be paid a dividend with the same priority afforded to employees. 

Recent case

This issue was recently considered by the Supreme Court of NSW where a company was placed into administration and shortly thereafter a related company paid employee superannuation entitlements directly to the employees on behalf of the Company.

Concurrently with the payments, the related company wrote to the administrators advising them that it had advanced the funds to the insolvent company in relation to outstanding employee entitlements.  This was not quite correct because the payments had in fact been made directly to the employees rather than advanced to the insolvent company.  The letter further stated that the payments were made pursuant to section 560 of the Act and subject only to the related company being afforded priority under that section.  

Outcome

In considering whether the related company was entitled to be subrogated to the priority claims of employees, the Court looked closely at the wording of section 560.  The judgment included the following passage:

“When invoking s 560, conformity with the actual language and internal structure of the provision is paramount, and if the apparent object of the provision (subrogation of the benefactor) cannot be achieved without doing violence to its wording, the provision is not engaged.  The fundamental difficulty in the present case is that none of the payments in question were made “by the company”, in terms of s 560(a):

[The related company] paid the relevant liabilities directly.  Section 560 only applies where the company (i.e. the company being wound up) pays the employee – related liabilities itself, using monies lent to it by the donor.”

The Court found that the conditions for subrogation under section 560 had not been satisfied because the strict wording of the Act had not been complied with given the payments were made directly to the employees rather than to the insolvent company and then on paid to the employees.  The Court held that the related company was not subrogated to the claims of employees pursuant to section 560 of the Act and as a result was not entitled to be paid a dividend in priority.

The Court then considered whether the related company was entitled to take advantage of the equitable doctrine of subrogation.  The Court considered this issue in a two stage approach.  Firstly, whether section 560 leaves any room for the operation of the equitable doctrine of subrogation and secondly, if so, whether the requirements of equitable subrogation were satisfied in this case.  The Court found that equitable subrogation is available in this scenario despite section 560, but in this particular case the payments were made spontaneously and voluntarily without any request from the administrators and therefore the basis for equitable subrogation was not established.

Lessons for business

Although it was clear that the related company made the payments to employees subject only to it being afforded the same right of priority as the employees, it ultimately did not receive priority given that the strict wording of section 560 had not been complied with.  This decision makes it clear that any person making a payment for the benefit of employees after a company has been placed into external administration must ensure strict compliance with section 560 of the Act, and in particular must advance the funds to the insolvent company rather than paying employees directly, in order to obtain the benefit of subrogation under the Act.