Looking after employees and your interests when money is tight.
Contemplating a company’s state of insolvency is a difficult position to be in. People’s livelihood and relationships are at stake, and usually, all energy is going into keeping the cash-flow, well flowing, and the focus is on keeping the product or services out in the world for the market to pay for.
And to keep the business wheels oiled, employees must be paid.
Often, directors will loan money to the company to pay wages/salaries/superannuation. However, there’s a little-known protection that directors can leverage in the worst-case scenario of an insolvency appointment.
Section 560 of the Corporations Act 2001 says that a person who loans money to a company before or after an insolvency appointment commences, to pay for wages, superannuation, and leave etc., will have the same rights to a priority payment. Essentially, it gives the person the same priority creditor rights, which employees had (i.e. a subrogation of rights).
This article discusses what happens when funds are loaned prior to a liquidation commencing. For example, when a company’s cash flow is suffering and needs funds injected to pay its employees. That lender can then claim as a priority creditor in an eventual liquidation. However, a liquidator will investigate the requisite elements to confirm the priority position exists.
Some simple steps to help establish this priority position are:
- The funds must be lent to the company and not paid directly to the employee/superannuation fund.
- The funds must be lent at the company’s request. That is, it is not volunteered by the loaner. An example of this is when a lender requires the express purpose of having a controlling vote in any subsequent liquidation.
- The accounting for the loan should be explicit in its purpose e.g. “loan to pay for employee entitlements—x period”. Another example is not grouping the loan into other loans. And the amount loaned should be reconcilable against the amount paid out to the employee/superannuation fund.
The message is for directors and their accountants/bookkeepers, if you intend to lend a company money for wages/salaries/superannuation ensure that it is accounted for correctly.
The necessity of the above steps is illustrated in the 2013 case of Dalma[1]. In this case, a related entity did not follow the steps above—as funds were directed to the employees (not to the company) and the loan was not made at the request of the company. Unfortunately, for the related entity, it lost its ability to ‘subrogate’ into the priority position of the employees for a dividend. This court decision was for around half a million dollars in employee entitlements. (Putting aside any commentary on the outcome in this liquidation).
The Government also relies on section 560 of the Corporations Act when making payment to external administrators under the Fair Entitlements Guarantee (FEG) scheme. When FEG pays out eligible employee entitlements, they can then lodge a proof of debt in the liquidation—through subrogating into the employees’ position. However, in the case of FEG payments, they are advanced directly to the employee—not to the company. The liquidator confirms in their deed of undertaking that FEG has the right of subrogation as if section 560 of the Corporations Act applies.
[1] Dalma No 1 Pty Limited (in liquidation)(ACN 111 772 260); Application of Bruce Gleeson and David Shannon in their capacity as joint and several liquidators of Dalma No 1 Pty Limited (in liquidation) an anor [2013] NSWSC 1335