The last few years have seen the Commonwealth increasingly crack down on misuse of the Fair Entitlements Guarantee, or FEG, program. The cases that have resulted have led to various disputes in insolvency law about the priorities of different creditors. The priorities to be applied in insolvent trading trusts have been one issue recently puzzling lawyers and insolvency practitioners alike. Relief may well be around the corner, however, as the High Court is set to weigh in.

What the FEG?

FEG is a legislative scheme set up by the Commonwealth as a safety net for employees of insolvent companies.

Essentially, workplace law in Australia provides that employees have a number of entitlements, such as annual leave. In the event that the company you work for becomes insolvent, the Commonwealth (through the FEG scheme) guarantees that you will be paid certain entitlements (including wages, leave, and redundancy) up to a certain threshold.

The Commonwealth then “stands in the shoes” of the employees of the company in liquidation to seek to be reimbursed for the benefits that it has paid out. As in most liquidations, the Commonwealth, like any creditor, will typically only recover cents in the dollar.

Jumping in line

When a company goes into liquidation there are invariably more debts than there are money to go around. In addition, the liquidators of the company need to get paid. Furthermore, there may be costs associated with liquidating the company’s assets to discharge the creditors.

Accordingly, it is important to know who gets the first slice out of the pie. Sections 555 to 559 of the Corporations Act 2001 (Cth) set out the ordinary priorities for the division of the assets. Generally speaking, they are:

  1. costs of preserving, realising, or obtaining the property of the company;
  2. the liquidator’s costs and expenses;
  3. preferential debts; then
  4. remaining creditors.

Employees of a company have a preferential debt, and accordingly stand ahead of the unsecured creditors of a company. Accordingly, if the Commonwealth pays out employee entitlements pursuant to FEG and stands in the employee’s shoes, they will rank ahead of most creditors in the division of company assets.

The boulevard of broken trusts

The situation is made more complicated when the company in liquidation is a trading trust, that is, a corporate trustee that is trading for the benefit of its beneficiaries.

A trust holds its property for the beneficiaries. It is well established that a trustee has a right of indemnity from trust assets, and that trust property is not available to creditors in insolvency.

Therefore, when the corporate trading trustee is insolvent the creditors cannot touch the trust property, but the company will dip into those assets pursuant to its indemnity. The question puzzling the courts have been what, if anything, is the effect in doing so? Are all of the creditors subrogated and therefore stand in line equally, or do the ordinary priority rules set out above apply?

The question has long been debated. The issue has hinged on the words “property of the company” in the statutory provisions setting out the priority of creditors in the Corporations Act. If the trustee’s right of indemnity is “property of the company” then ordinary priority rules will apply (meaning that the liquidator and FEG get first bites at the pie). On the other hand, if a trustee’s right of indemnity is not property, then everything is to be distributed according to trust principles (no priorities).

Back in 1983, two different courts reached different conclusions. The Full Court of the Supreme Court of Victoria, in Re Enhill Pty Ltd [1983] 1 VR 561 found that the ordinary priority rules applied. The Supreme Court of South Australia found the other way in Re Suco Gold (1983) 33 SASR, holding that liquidators were not entitled to costs and expenses of winding up out of trust monies, as they were not “property of the company”.

In 2016, Brereton J of the Supreme Court of NSW followed the South Australian approach in Re Independent Contractor Services [2016] NSWSC 106, followed by Markovic J of the Federal Court in the 2017 decision of Mooney’s Contractors Pty Ltd (in liq) v Mooney [20017] FCA 653.

This has led to Victoria becoming increasing isolated on this issue. It appeared that this isolationism would be reversed by Robson J of the Supreme Court of Victoria in Re Amerind Pty Ltd (in liq) [2017] VSC 127. In that case, his Honour rejected Re Enhill and elected to instead follow Re Independent.

This uniformity was short lived, however, as the Court of Appeal of Victoria recently reversed Robson J’s decision on appeal in Commonwealth of Australia v Byrnes and Hewitt [2018] VSCA 41.

Byrning it all down

The reversal from the Victorian Court of Appeal appears to be based on a reading of the High Court’s decision in Octavo Investments Pty Ltd v Knight (1979) 144 CLR 360. In this case, the High Court held that in circumstances where a corporate trustee used its right of indemnity to pay a trust creditor from trust property, this could be subject to a clawback for an unfair preference.

The Court of Appeal reasoned that this clawback would only be possible if the trustee’s right of indemnity was property that vested in the liquidator. This conclusion is not expressly supported by the High Court’s judgment in Octavo.

The issue has been left further confused by the recent decision of the Full Court of the Federal Court in In re Killarnee Civil & Concrete Contractors Pty Ltd (in liq) [2018] FCAFC 40, which has followed Victoria’s lead on the issue.

Special leave granted

Fortunately this issue may finally have clear resolution. At the special leave hearing before the High Court last month, Gageler, Nettle, and Edelman JJ after hearing oral submissions (only from the respondent) granted special leave to appeal.

The key issue for the Court to resolve is whether “property of the company” includes a trustee’s right of indemnity and any trust assets. The case will likely be heard in the early new year. Insolvency practitioners and solicitors will be watching this decision closely and look forward to the High Court providing some certainty on this issue.