A decision in 2013 from the New South Wales Supreme Court sheds light on the ability of creditors to subrogate into priority positions. Subrogation occurs where a creditor or person agrees to pay priority creditors of the company in liquidation in consideration for the right to subrogate into the priority position of that priority creditor paid. For instance, a related party of the company in liquidation may elect to pay the employee entitlement of that company in consideration for the right to subrogate into the priority position of employees.
In relation to s 560 of the Corporations Act 2001 (Cth) (the Act), general practice has been to subrogate creditor claims, particularly where a third party pays the employee entitlements of the liquidated company (whether directly or indirectly).
Usually general practice is to admit a claim for subrogation provided the creditor can evidence they paid a valid company debt, thereby allowing them to stand in the shoes of the creditor (i.e. when FEG pays employee entitlements and subrogates into priority status). However, the below case considerably changes the scope of these rights as discussed below.
Case Law – The Dalma Case
In re Dalma No 1 Pty Limited (In Liquidation) and Anor NSWSC 1335 (the Dalma case) his Honour, Brereton J, has delivered a judgment quite contrary to usual practice with respect to the application of this section of the Act.
In the Dalma case, a related party paid wages directly to the staff (rather than advancing the monies to the company and the company paying the wages itself) and sought the Liquidators consent to subrogate into the priority position of the employees paid. In a considered judgment, Brereton J interpreted s 560 of the Act as only applying to those payments ‘made by the company’ rather than ‘made by a company’. Practically speaking, this means that for the right to subrogate to occur, the related party was required to transfer the money directly to the company with instructions to pay the company’s wages.
This view is further ratified in the explanatory memorandum to the amendments made to the Act in 2007. Accordingly, the related party claim was held to be an unsecured debt rather than a priority debt in the Liquidation.
Background
The facts of the Dalma case were as follows:
- Dalma No 1 Pty Limited (the company) was placed into administration on 13 May 2010, and subsequently into liquidation on 18 June 2010;
- The liquidators of the company applied to the NSW Supreme Court (NSWSC) for orders declaring whether or not Dalma Constructions, a related party, (the related party) was entitled to subrogation under s 560 of the Act;
- The company owed employee entitlements (including unpaid leave, superannuation, redundancy trust and income protection insurance) totalling $598,767.09 at the time of the administration;
- The related party made the following payments in favour of the employee entitlements:
- On 17 May 2010 a payment of $77,663.18 was made directly to CBUS;
- On 17 May 2010 a payment of $52,485 was made to the Australian Constructions and Industry Redundancy Trust (ACIRT);
- On 17 May 2010 a payment of $11,833 was made to U-Plus in lieu of income protection insurance contributions; and
- On 7 June 2010 further payments totalling $57,820.85 were made in favour of CBUS, ACIRT and U-Plus,
- (collectively, the employee entitlement payments).
- The final payment, on 7 June 2010, was made subject to the conditions in a letter sent by the related party to the administrators. The letter provided that the final payment was subject to the related party’s debts, in the event that the company was wound up, being subrogated to the priority level that employees would have otherwise enjoyed.
Therefore, the question was put to Brereton J, whether or not the related party’s debts could be subrogated (whether under statute or equity) to the level otherwise enjoyed by employees.
The Decision
His Honour held that s 560 of the Act only applies where the payments are made by the company, for whose benefit those payments were made, on behalf of the party claiming subrogation. Justice Brereton, in a single judgment, held that:
- The related party creditor was not entitled to subrogation under s 560 of the Act, because it had directly paid the employee entitlements, and not through the company;
- Equitable subrogation continues to exist alongside the operation of s 560 of the Act; and
- Voluntary payment will not afford equitable subrogation, except in the special case where those payments were for securities (ie secured interests).
He came to this decision by reference to:
- What was said in Capt’n Snooze Management Pty Limited v McLellan VSC 432 (the Capt’n Snooze case), namely that no ‘violence to its wording’ can be tolerated – meaning that every word in the section must be read together to determine the internal structure of s 560 of the Act; and
- Paragraph (a) of s 560 of the Act, namely, he described it as ‘made by the company,’ as opposed to ‘made by a company.’ The implication being that the employee entitlement payments needed to have been paid to the company, in lieu of CBUS, ACIRT and U-Plus.
Whether or not the company is in liquidation at the time of the payment, the creditor needs to have paid the advance to the company and then the company make the payment to the creditor itself for the type of payment to retain its priority in a liquidation scenario. If not, they will be an unsecured creditor.
Failing this, if the company has been placed into Voluntary Administration and a related party paid the employees directly, in order to keep it trading prior to our appointment, we could always exercise our judgement under the Act as a commercial payment.
The above case is a timely reminder for Liquidators and those creditors seeking subrogation to apply s 560 of the Act as it was intended to be applied and to seek expert advice.
It is worth noting there have been a number of decisions, most recently Re Divitkos; Ex DVD Pty Ltd (In Liquidation) (2014) which have dealt with a secured creditor’s rights of subrogation, where circulating assets are used to pay employee entitlements and later preferences are recovered in a liquidation.
Typically, recoveries from preferences in a liquidation were not available to a secured creditor.
In the Divitkos case, Justice White noted “There is no all-embracing theory which explains where subrogation should be permitted”. The court recognised this case did not fall into any of the established categories of subrogation, however Justice White determined “an equitable right of subrogation should be recognised”.
“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.”
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