WHAT HAPPENED?

In Re Perthmetro Pty Ltd (in liq) [2015] FCA 671, the liquidator of Perthmetro Pty Ltd, a construction company specialising in commercial buildings, sought a determination from the Federal Court of Australia as to whether he should allow four of Perthmetro’s former employees to prove for their unpaid employment entitlements in the liquidation.

The liquidator questioned whether the employees should be allowed to do so given their employment contracts were ‘tainted by illegality or [were] offensive to public policy’. The contracts were said to be tainted because they were part of an arrangement designed to reduce the income tax liability of the employees.

The arrangement was relatively simple. Two of the employees worked full-time at Perthmetro for which they received a salary. However, in addition to that salary, the wives of these two employees also received a further payment for their husbands’ work. One of the wives received this payment in addition to a salary she earned working part-time for Perthmetro, while the other wife did no work for Perthmetro at all, and received only the payment from Perthmetro for her husband’s work.

THE APPLICATION

The application was made pursuant to section 511 of the Corporations Act 2001 (Cth). This section allows liquidators to apply to the Court to determine any question arising in the winding up of a company. Whilst this is ordinarily used by liquidators to obtain advice from the Court as to the proper course of action, the Court also has the power to make orders affecting substantive rights of third parties.

This discretionary power will only be used by the Court where the third parties will not suffer injustice and where they are offered an opportunity to be heard in respect of any such orders that might adversely affect their rights or interests.

As each of the former employees had been served with a copy of the originating process by the liquidator (which outlined what he was asking the Court), but had declined to appear at the hearing, the Court considered that it could proceed to determine the liquidator’s question.

THE DECISION

The Court found that each of the four employment agreements represented an “income splitting arrangement” and were structured, with the knowledge of the husbands, the wives and the company, so as to reduce the income tax which would otherwise have been payable.

The wives’ employment agreements were said to be falsely based as they were receiving payments forming part of their husband’s income with the sole purpose of reducing their husband’s tax liability.

It is well-established that a person who enters a contract with the fraudulent purpose of deceiving and thereby defrauding the revenue authorities is not entitled to have a court enforce the rights conferred under the contract. In relying on this principle, the Court ordered that, with the exception of the entitlements genuinely earned by one wife for her part-time work, none of the four ‘employees’ could prove their entitlements in the company’s liquidation.

COMMENT

Liquidators and other insolvency practitioners should consider whether any arrangements entered into by the insolvent company are fraudulent or otherwise tainted by illegality.

While some of these arrangements may give rise to substantive claims against former directors, officers, or employees, this decision demonstrates that fraudulent arrangements may also allow the liquidator to apply to the Court for a determination that fraudulent employees should be prevented from proving their employment entitlements in the insolvency.

In the case of any obvious illegality, the Court will likely grant such orders provided the former employees are given an opportunity to be heard in respect of such issues.