Introduction

On 1 July 2015, the Commonwealth Government launched the Fair Entitlements Guarantee Recovery Programme for an initial period of two years. The purpose of the Recovery Programme is to increase the prospects of the Commonwealth recovering amounts it has paid to former employees of companies in liquidation pursuant to the Fair Entitlements Guarantee Scheme[1]. 

This purpose is to be achieved by the Commonwealth providing litigation funding, where appropriate, to liquidators in order to enable recovery action to be taken against third parties with a view to increasing the assets available for distribution in the winding up. The Recovery Programme signals a structured foray by the Commonwealth into the world of litigation funding in the insolvency market.

The significance of the Recovery Programme

The introduction of the Recovery Programme is significant to the Australian insolvency market for a number of reasons.

The good news for liquidators is that the Recovery Programme is a potential source of funding for liquidators to pursue claims. 

This may in turn result in some increase in recovery actions against directors and officers (and their insurers). Similarly, recovery action against other "frequent flyer" unfair preference recipients such as the revenue authorities may also be expected (raising the prospect of tension within the Commonwealth Government).

The bad news for receivers, and their secured creditor appointors, is that it appears that the Recovery Programme also intends to scrutinise whether receivers are complying with their obligations under section 433 of the Corporations Act 2001 (Cth).[2] Section 433 obliges a receiver to pay certain employee entitlements (including wages and superannuation) from the proceeds of property subject to a circulating security interest before making any payment to the receiver's appointor. This invites close attention to both the drafting and administration of the "fixed charge" and "circulating security interest" (or "floating charge") elements of a general security interest -While labelled a fixed charge, a security interest may be properly re-characterised as a "circulating security interest" because of the manner in which the grantor was able to deal with the assets subject to the security interest during its lifetime.

The problem with the Fair Entitlements Guarantee Scheme

Where a company is being wound up, the liquidator is obliged to pay priority employee entitlements before he or she pays the debts owing to other unsecured creditors.

If there are insufficient assets available for the liquidator to pay these employee entitlements, the former employees may apply to the Commonwealth pursuant to the Fair Entitlements Guarantee Scheme for payment of certain of their entitlements. The Scheme is designed to be a safety net for employees where no other avenue exists for them to be paid their employee entitlements due to their employer's liquidation.

After making a payment to an employee pursuant to the Scheme, the Commonwealth then steps into the employee's shoes as a creditor in the liquidation pursuant to section 560 of the Corporations Act 2001 (Cth). This means that the Commonwealth has the same priority ahead of unsecured creditors as the employee had before receiving his or her Scheme payment.

The problem for the Commonwealth is that it will only recover its outlay if there are sufficient funds available in the winding up - and recovery appears to be a relatively rare occurrence. In the 2013-2014 financial year, $197,193,316 was paid to employees under the Scheme (and its predecessor, the General Employee Entitlements and Redundancy Scheme) but only around $16.48 million was recovered by the Commonwealth from liquidated companies through creditor dividends in the winding up process[1].

The Fair Entitlements Guarantee Recovery Programme

The Recovery Programme looks to improve the Commonwealth's modest recovery rate.

The Recovery Programme may provide funding to liquidators to pursue claims (for example, claims against creditors in respect of unfair preferences or claims against directors in respect of alleged insolvent trading) with a view to increasing the assets available for distribution to the Commonwealth where it has stepped into the shoes of a former employee.

The funding for the Recovery Programme is limited, accordingly a liquidator can expect that he or she must be able to demonstrate that the prospects of success of the claim are good, the prospective defendant has the financial capacity to pay (including whether a D&O insurance policy exists) and the recovery will increase the return to the Commonwealth (rather than be used to meet a shortage of funds available for the liquidator's remuneration).  Applicants for funding will need to complete a 'Funding Application', which will set out that information, as well as other factors - such as an indication of the company's creditors (with an understandable focus on priority claims), and the expected costs of litigating the matter to judgment[2]. 

Given that around 57% of external administrators' reports reported possible breaches of section 588G of the Corporations Act and around 27% reported possible breaches of section 180 of the Corporations Act in the 2013 - 2014 financial year[3], the availability of additional funding for liquidator claims is also bad news for directors of companies that are in liquidation.  

It has also been reported that the Recovery Programme may also target receivers to ensure that employee entitlements are paid in priority from the proceeds of property subject to a circulating security interest pursuant to section 433 of the Corporations Act[4]. It appears that the Recovery Programme will lead to greater scrutiny of the allocation of the purchase price between property subject to a circulating security interest and property subject to a non-circulating security interest where a receiver sells a number of assets of different kinds together. That is because a receiver's appointor would prefer to see as little value as possible attributed to the property subject to the circulating security assets (and as much as possible attributed to the non-circulating security assets) so as to maximise the amount distributed to itself, rather than employees.

[1] Department of Employment Annual Report 2013-2014, page 39.

[2] Available at: https://employment.gov.au/FEGRecoveryProgramme

[3] Australian Securities & Investments Commission, Report 412 Insolvency statistics: External administrators' reports (July 2013 to June 2014) dated September 2014, page 26.

[4] Gosnell, P. FEG Scheme to target banks on Section 433. Available from: http://sydneyinsolvencynews.blogspot.com.au/2015/07/feg-scheme-to-target-banks-on-section.html