The Federal Government will soon release draft legislation that, if passed into law, will reform Part 5.8A of the Corporations Act 2001 (Cth) (the Act). The reforms are part of a wider policy to curb the misuse by corporates of the Fair Entitlements Guarantee (FEG) which often leads to the cost of employee entitlements being shifted to the taxpayer.

The reforms were foreshadowed in a recent press release from the Minister for Revenue and Financial Services, Kelly O’Dwyer MP and the Minister for Employment, Senator Michaelia Cash. A Consultation Paper had been released earlier this year and the Government concluded the public consultation process in July.

Background

The aim of Part 5.8A is to protect employee entitlements (which enjoy preferential payment in a winding up) from agreements and transactions that are entered into with the intention of defeating the recovery of those entitlements.1

The Consultation Paper notes that no court actions against corporations, criminal or civil, undertaking practices under Part 5.8A, have ever been successful despite wide spread use of practices aimed at avoiding employee liability obligations in an insolvency scenario (often associated with phoenix conduct).

Proposals

In order to address corporate action which leads to the exploitation of FEG, the Government has proposed 4 options for reform of Part 5.8A in the Consultation Paper.

Option 1: Extend the fault element in section 596AB of the Act to include recklessness and increase the maximum penalty.

Section 596AB currently provides that a person must not enter into a relevant agreement or transaction “with the intention of, or with intentions that include the intention of” preventing recovery of entitlements of employees or significantly reducing the entitlements of employees.

Option 1 proposes to extend the fault element to include a person’s reckless intention to enter an agreement. Recklessness, is a level of culpability “where a person is aware of a substantial risk”2 that something exists or will occur but nevertheless proceeds.

The Government suggests this change will enable liquidators and employees to “more easily undertake civil recovery action”3 when used in conjunction with section 596AC of the Act, dealing with the recovery for loss or damage under section 596AB.

In addition to the above, the Government recommends that consideration should be given to increasing the maximum penalties for breaches of section 596AB from the current penalty of 1000 penalty units or ten years imprisonment to 4,500 penalty units or three times the loss suffered.

Option 2: Introduce a separate civil penalty provision with an objective test

The Government has proposed creating a civil penalty provision which is separate from the criminal offence provision in section 596AB.

Civil penalties, the Consultation Paper states, are a “punitive sanction imposed by a court” with the penalty “often being financial in nature” and “would give rise to a right to seek a compensation order”. As such, the existing compensation order under section 596AC would be superfluous and repealed.4

The civil penalty provision would be based on an objective test. Two options have been suggested by the Government:

  1. Option 2A - a test based on whether the reasonable person would have known or expected to have known that the agreement or transaction in question would cause the loss or damage. This approach, the Government states, would result in a “broader capture of behaviour and operate as a more effective deterrent to reduce sub-optimal corporate practices, so reducing the costs of and moral hazard associated with the FEG scheme.”5
  2. Option 2B – a test based on an objective assessment of the agreement or transaction which caused loss or damage to employees due to the avoidance of the payment. This option, the Government states, may include consideration of factors such as:
  • the benefit or detriment to the company in entering into the agreement or transaction;
  • the respective benefit or detriment to other parties; and
  • whether the agreement or transaction was commercially reasonable.6

Option 3: Expand the parties who may initiate civil action

Pursuant to section 596AC(2) a liquidator of the company (and former employees pursuant to section 596AC(3)) can bring a civil action against persons involved in a contravention of section 596AB. In such circumstances an amount equal to the loss or damage is recoverable as a debt due to the company.

The Government has suggested a wider range of parties who may apply under section 596AC to lead to “enhanced recovery”,7 where the liquidator does not intend to bring an action, these include:

  • the Department of Employment;
  • the Fair Work Ombudsman; and
  • the Australian Taxation Office.

Option 4: Addressing other issues with the current Part 5.8A drafting

The final option tabled by the Government addresses other issues with Part 5.8A, including the “lack of clarity”8 relating to the scenarios and circumstances in which Part 5.8A is intended to operate, where and who it applies to, and the deterrent impact that an amended section 596AB may have as a criminal offence.

The Government’s Consultation Paper does not outline specifics but suggests the following possible changes:

  • extend the matters to which Part 5.8A applies to capture a “wide range of potential behaviours which can lead to the avoidance of employee entitlements”;9
  • ensure the definitions of ‘relevant agreements’ and ‘arrangements’ are broadly defined in section 9 of the Act to include informal arrangements and understandings; and
  • adopt a wide and comprehensive definition to the matters to which Part 5.8A applies, which could be similar to the definition of ‘scheme’ in section 177A of the Income Tax Assessment Act 1936 (Cth) (i.e. applies to agreements and understandings, as well as promises, plans, proposals, actions, undertakings and courses of conduct).

Conclusion

The Federal Government has recognised that certain corporate practices are leading to more reliance on FEG to account for unpaid employee entitlements. It is also clear that many of these practices are associated with phoenix behaviour. The Government is also looking to address this through ASIC’s proposed anti-phoenixing measures. However, it remains to be seen, which (if any) of the proposals outlined will indeed achieve the stated purpose of the reforms. The current Part 5.8A already provides the means for prosecution and allows for civil recovery (which, it could be argued, should be used more regularly as a means of pursuing directors who are engineering such practices).

Of broader importance is arguably not the success rate of Part 5.8A claims (one suspects that not many cases are in fact ever commenced) but rather the appetite and ability of liquidators to pursue such claims. Critical to this is the funding of Part 5.8A claims. Accordingly, an increased willingness on the part of FEG (and others) to fund liquidators to pursue directors and companies engaged in conduct which is likely to impact upon the recovery of employee entitlements, may be just as significant as the proposed reforms in achieving the desired outcomes.

We will provide a further update once the Government’s draft legislation has been released.