In brief

The recent decision of Divitkos, In the matter of Ex DVD Pty Ltd (In liquidation) has paved the way for secured creditors who pay employee entitlements out of secured assets to receive a priority for that payment from preference claims recovered in a subsequent liquidation.

Summary

The recent decision of Divitkos,In the matter of Ex DVD Pty Ltd (In Liquidation) dealt with the situation where receivers appointed by a secured creditor paid a significant sum out of floating charge assets (ie the insolvency occurred prior to the enactment of the PPSA, but the same principles will apply with respect to ‘circulating assets’) in satisfaction of employee entitlements.

The company fell into liquidation, and the liquidator recovered funds by way of preference claims, which recoveries were not the subject of the secured creditor’s charge. However, the secured creditor successfully argued that it was entitled to be repaid the amount of those employee entitlements as a priority (ie in front of unsecured creditors).

Facts

  • On 16 December 2008, the Commonwealth Bank of Australia (CBA) appointed receivers under its fixed and floating charge over Ex DVD Pty Ltd (Ex DVD). On the same day, but after the receivers were appointed, the director of Ex DVD appointed voluntary administrators.
  • The receivers took control of the assets and business of Ex DVD and traded until 21 January 2009, at which point the business was sold. Notwithstanding the sale, the CBA suffered a significant shortfall.
  • In April 2009, the creditors of Ex DVD resolved to wind up the company and the administrators became the liquidators.
  • In the period 18 December 2008 to 21 August 2009, the receivers made eight payments totalling approximately $945,000 from the proceeds of sale of floating charge assets secured by CBA’s charge in respect of employee entitlements, being wages, superannuation, leave, redundancy and retrenchment payments. Although the case related to a period prior to the commencement of the PPSA, there is no reason to believe that the principles will not be applicable to ‘circulating assets’ (ie as floating charge assets are now described).
  • At the time of the hearing, the liquidation of Ex DVD was nearly concluded and the liquidators held approximately $1.4 million as proceeds of preference claims (which proceeds would not be the subject of CBA’s security).
  • CBA claimed that it was entitled to be paid the $945,000, which its receivers had paid by way of employee entitlements, out of the preference claim proceeds held by the liquidator, in priority to the unsecured creditors, on the basis that CBA’s security had been diminished by the receivers paying that amount to the employees.
  • CBA contended that each of the payments made by the receivers was made pursuant to section 433 of the Corporations Act and it had an entitlement to a priority in the liquidation, because it was entitled to be subrogated to the rights of the employees whose claims have a statutory priority.

Statutory provisions

In a liquidation, section 556 of the Corporations Act provides for the ranking of claims and sub-sections 556(1)(e), (f), (g) and (h) give a statutory priority to specified employee entitlements.

Section 433 provides that where a receiver is appointed before a company has commenced to be wound up, then the receiver:

must pay, out of the property coming into his, her or its hands, the following debts or amounts in priority to any claim for principal or interest in respect of the debentures:

(c)          subject to sub-sections (6) and (7), any debt or an amount that in a winding up is payable in priority to other unsecured debts pursuant to paragraph 556(1)(e)(g) or (h) or section 560.’

White J noted that section 433 is not qualified, and that it imposes an obligation on the receiver to pay employee entitlements as soon as the receiver or controller has possession or control of the company’s property. This is to be contrasted with the situation in a winding up where, as a consequence of the decision in Cook v Italiano Family Fruit Company Pty Ltd [2010] 190 FCR 474, employee entitlements ought not to be paid out of secured assets until it is known that there will not be sufficient ‘free assets’ (ie assets not subject to security) to pay the employee entitlements.

Is there a right of recoupment or subrogation?

White J noted that there was no statutory right of recoupment set out in the Corporations Act and, although it may be possible to determine the existence of an equitable right of recoupment, such a right would not benefit CBA, because a right of recoupment, by itself, would not give any priority over unsecured creditors. In order to achieve such a priority position, the CBA needed to argue that it was entitled to be subrogated to the priority position of the employees (ie whose entitlements had been paid out of the secured assets).

White J reviewed relevant cases and concluded that equitable subrogation is not excluded by the Corporations Act, and that there may be circumstances in which a secured creditor, whose security has been diminished by the making of priority payments pursuant to section 433 (or 561) of the Corporations Act, may be subrogated to the rights of the priority creditors.

His Honour relevantly held that:

In my opinion, the situation of a secured creditor or of a receiver appointed to a company by a secured creditor who, in accordance with section 433 of the Corporations Act, makes payments to priority creditors, is analogous to that of a person who, other than voluntarily, discharges the security of another. That is a well-recognised circumstance in which rights of subrogation arise. The payors in such circumstances are presumed to have preserved the security for their own benefit.’ (Paragraph 77, authorities removed).

Rather than intending a loss of a security [a receiver’s] function is to preserve and realise the security. It would be inappropriate to impute an intention by them to forgo that security when they make payments required by law. For the unsecured creditors or for the company itself to seek to have the benefit of the compulsory payment would, in my opinion, be both opportunistic and unconscionable.’ (Paragraph 78)

In other words, because section 433 compelled the receivers to pay employee entitlements, in the subsequent liquidation, CBA was entitled to be subrogated into the shoes of the employees, and take their priority under section 556 of the Corporations Act.

Outcome

As a result of this decision, in circumstances where a secured creditor’s security position has been diminished by reason of payments made to employees under section 433:

  • the secured creditor obtains priority access to the proceeds of preference claims, and
  • the pool of funds available to unsecured creditors is accordingly reduced.

This decision also confirms that secured creditors, who have paid employee entitlements, are a potentially good source of funding for liquidators chasing preference claims (ie as they may benefit from successful recovery).