The Federal Court affirms that a secured creditor may be subrogated to the entitlements of priority creditors, to the extent that the Receivers’ payments to priority creditors have diminished its security.

In the recent case of Divitkos, in the matter of ExDVD Pty Ltd (in liquidation) [2014] FCA 696, the Federal Court was asked to consider the position set out in Cook v Italiano Family Fruit Company Pty Ltd (in liq) [2010] FCA 1355 (Cook). That is, whether a secured creditor may be subrogated, to the extent that the Receivers’ payments to priority creditors diminish its security, to the entitlements of those creditors to the free funds.

The proceedings concerned the receivership and subsequent liquidation of ExDVD Pty Ltd (ExDVD), a DVD retailing company. In late 2008, the Commonwealth Bank of Australia (CBA) appointed Receivers to ExDVD and in 2009, the creditors of ExDVD resolved to have the company wound up.

Before ExDVD was wound up, the Receivers paid ExDVD’s employee entitlements of $924,557.44 out of the property secured in favour of CBA.

Overview

The liquidator sought directions from Justice White of the Federal Court in relation to 2 issues.

First, could CBA recover the amount paid by the Receivers to employees in priority to other unsecured creditors, by subrogation or otherwise?

Secondly, if CBA was to recover in priority to other unsecured creditors, could the liquidator determine priority on the basis of the evidence provided by CBA as to the payments made or should the liquidator require proof of each of the underlying claims of the employees in respect of whom the payments were made?

Issue 1: What is the priority position and does a right of subrogation exist?

In short, in answer to the first question, the Court held that CBA was subrogated to the rights of the employee priority creditors paid by the Receivers.

Whilst the Court found that this case does not fall into any of the established categories of subrogation, it also found that those categories are not exclusive. Instead, it was acknowledged that there is no all-embracing theory which explains when subrogation is permitted.

Justice White found that a secured creditor who, in accordance with s 433 of the Corporations Act, makes payments to priority creditors, falls within the category of subrogation which arises where a third party discharges another person’s security.

His Honour highlighted the fact that receivers are obliged to act in the interests of both their appointers as well as the company to which they are appointed and to preserve and realise security. As such, his Honour stated that “it would be inappropriate to impute an intention by them to forego that security when they make payments required by law” and it would be “both opportunistic and unconscionable” to allow unsecured creditors or the company itself to seek a benefit from the compulsory payment.

Issue 2: What evidence of the debt is required?

In regards to the evidence of debt required, the Court held that the evidence to support debt claimed by CBA is a matter for the plaintiff liquidator to determine, in the same way as would occur for all proofs of debt.

Commercial implications

Secured creditors and Receivers can take comfort from the affirmed position that a secured creditor’s claim has priority over unsecured creditors in a liquidation to the amount of payments made by Receivers pursuant to s 433, by virtue of subrogation rights.

In proving the debt in the liquidation, the secured creditor should provide all evidence of the subrogated claim. It should adopt the same approach as if it were seeking to establish its debt in the ordinary course.