Liquidator's remuneration vs employee creditors: who gets priority to circulating assets?

Written by Sam Johnson (Partner), Emily Barrett (Partner) and William Honeysett (Associate)

Commonwealth of Australia v Tonks [2023] NSWCA 285

In this decision, the Court of Appeal of the Supreme Court of NSW considered the interplay between the priority regimes under ss 556 and 561 of the Corporations Act 2001 (Cth) (Act) in resolving a contest between a liquidator’s claim for remuneration and the entitlements of former employees to be paid out of circulating assets.

The Court of Appeal confirmed the first instance decision of Justice Black in finding that:

• s561 applies only in respect of a contest over access to circulating assets as between a secured creditor (with security over the circulating assets) and priority employee creditors and only where there is an insufficiency of circulating assets to satisfy both sets of creditors;
• in those circumstances, s561 of the Act will give priority creditors an entitlement to be paid ahead of secured creditors out of the circulating asset pool;
• however, where s561 is not engaged, s556 of the Act will provide the appropriate priority regime to deal with contests between a liquidator’s remuneration and expenses and priority employee creditor claims
• accordingly, s561 will not override the priority regime set out in s556 of the Act, which sets out the specific priority positon as to unsecured creditors in the winding up of a company.

The Court also provided guidance as to when a liquidator is to determine when s561 applies and at what point a company’s assets are characterised as circulating assets.

Background

On 18 March 2019, BCA National Training Group Pty Ltd (Company) by a resolution of its members appointed a liquidator, Mr Bradley Tonks (Liquidator). Westpac held a security interest over all the Company’s property. The Liquidator realised $168,709.91 from the Company’s non-circulating assets and paid out its debt to Westpac from those funds. The Liquidator then realised $550,344.64 from the Company’s circulating assets. The claims of the priority creditors, including the Department of Employment and Workplace Relations on behalf of the Commonwealth of Australia (Commonwealth), amounted to $480,293.65. The Liquidator’s remuneration, costs and expenses amounted to $570,613.44.

At first instance, the Liquidator obtained a direction pursuant to s 90-15 of the Insolvency Practice Schedule in Sch 2 to the Act that authorised distribution of the Company’s circulating assets in accordance with the order of priorities set out in s 556 of the Act. The Court agreed with the Liquidator that his remuneration, costs and expenses took priority over the Commonwealth’s claim to pay out entitlements of the Company’s former employees according to s 556 of the Act.

The Commonwealth had sought to rely on s 561 of the Act, which provides that if the property of a company available for payment of creditors other than secured creditors is insufficient to meet payments of certain debts, employees’ claims have priority over circulating security interests.

On appeal, the Commonwealth submitted that the purpose of s 561 of the Act was to entitle employees to be paid out of circulating assets in circumstances where their entitlements could not be met from the free assets of the company. On that basis, the Liquidator’s claim did not rank ahead. Further questions that arose before the Court regarded the operation of s 561 of the Act, namely, as to when it applies (whether at the appointment date or when the liquidator determines that the free assets are insufficient to meet the priority employee entitlements) and at what point company assets are characterised as circulating assets.

Issues

The key issue before the Court of Appeal was whether ss 556 or 561 of the Act applied to determine the priority dispute between the Liquidator’s claim for remuneration and expenses and the priority employee creditor claims.

Findings

The Court of Appeal (in upholding the primary judge’s decision) held that:

1.     s561 of the Act provides a priority regime which deals with contests between secured creditors and priority employee creditors with respect to a company’s circulating assets where the free assets of a company are insufficient to satisfy the priority creditor claims; and

2.     s561 of the Act does not apply unless there is a contest for payment out of a company’s circulating assets between a secured creditor and a priority creditor.

Therefore, s561 of the Act did not apply on the facts as (following discharge of the debt to Westpac) there was no secured creditor claim that competed with priority employee creditor claims.

The Court also held that the insufficiency threshold in s 561 of the Act would usually only be determinable after a liquidator had been appointed and was in a position to determine that the free assets of the company were insufficient to meet the payments of priority creditors. Further, the Court held that assets which are characterised as circulating at the date of appointment of the liquidator will retain that character for the purpose of s 561 of the Act as long as the section otherwise applies.

Implications

In a decision that will be welcomed by liquidators, the Court of Appeal has made it clear that the operation of s561 of the Act is contingent in nature. The section will only apply where there is a contest between secured creditors and priority employee creditors for the proceeds of circulating assets. Its application is assessable at the time when there is an insufficiency of free assets to satisfy priority employee creditors. The decision confirms that where a secured creditor has been paid out of fixed assets so that there is no competing secured creditor claim, s 556 of the Act provides the sole regime for dealing with contests between a liquidator’s claim for remuneration and expenses and priority employee creditor claims.

 

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