Two recent decisions have contradicted long-standing authority, resulting in both the Commonwealth and the ATO losing priority status. This is due to an unusual gap in the priority regime created under the Corporations Act. Importantly, these decisions mean that secured creditors will have priority over the claims of employees in respect of circulating security interests.

The Federal Employment Minister, Senator the Hon. Michaelia Cash, has stated that the Federal Government is committed to strengthening measures to prevent employees and taxpayers being left out of pocket as a result of corporate failures.1 Although no specific proposals have been announced, the case for reform is real and immediate.

Senator Cash's statement follows two recent decisions in which the Court in both cases held that the priority regime in section 556 of the Corporations Act does not apply to trust assets.

INDEPENDENT CONTRACTOR SERVICES (AUST) PTY LIMITED (IN LIQUIDATION) (NO 2) [2016] NSWSC 106

What happened?

Independent Contractor Services (Aust) Pty Ltd was the trustee of a trading trust. The sole function of the Company was to administer the trust.

In 2012, the Company was wound up. At that time, there were amounts standing to the credit of the Company in its bank account. In an earlier decision, the Court held that those amounts were held on trust for the trust's beneficiaries.

The Australian Tax Office (ATO) lodged a proof of debt which included an amount in respect of the superannuation guarantee charge (SGC) (being a tax liability of employers calculated by reference to the wages an employer has paid to its employees). As section 556(1)(e) of the Corporations Act affords priority to any SGC payable ahead of claims of ordinary secured creditors, the ATO sought to be paid in priority to other creditors.

What did the Court decide?

However, the Court's view was that because section 556 deals with the distribution of assets which are beneficially owned by a company, rather than assets which are held on trust, the ATO could not be afforded priority over other creditors under section 556(1)(e). This view is in stark contrast to the long-held view that the priority regime in section 556 applies to all assets of a company in liquidation, including trust assets.

As all the Company's liabilities were incurred in its capacity as a trustee of the trust, all of its creditors (including the ATO), were entitled to be subrogated to the company's right to be indemnified from the trust assets for liabilities incurred in administering the trust (which right then passed to the liquidator), and therefore to share equally in the trust assets.

RE AMERIND PTY LTD (RECEIVERS AND MANAGERS APPOINTED) (IN LIQUIDATION) [2017] VSC 127

What happened?

Amerind was also the trustee of a trading trust, the sole business of which was to operate the trust. When administrators were appointed to Amerind in March 2014, Bendigo and Adelaide Bank (Bank), with which Amerind held a number of facilities, appointed receivers and managers to Amerind on that day. Shortly after, Amerind's creditors resolved that it be wound up and the administrators were appointed as liquidators.

The receivers traded on after their appointment and realised Amerind's assets. The Bank's debt was paid out and, after the receivers' remuneration was paid, there was a surplus of approximately $1.6 million. That amount was subject to a circulating security interest, such that section 433 of the Corporations Act applied. Section 433 sets out a priority regime in respect of realised assets which are subject to a circulating security interest.

The Commonwealth had paid accrued wages and entitlements in the sum of approximately $3.8 million to Amerind's former employees under the Fair Entitlements Guarantee Scheme and sought to recover those monies as a priority under sections 433 and 560 of the Corporations Act. Sections 433 and 560 incorporate section 556, thereby affording priority to payments made in respect of wages and entitlements ahead of claims of ordinary unsecured creditors.

Was the receivership surplus trust property?

The parties agreed that Amerind acted solely as trustee of the trading trust. It incurred liabilities in its capacity as trustee, and its creditors were therefore trust creditors. It had no assets of its own, such that it had a right to be indemnified from the trust assets in respect of liabilities incurred in carrying out the trust. For that reason, the receivership surplus was held to be trust property. Similarly to Independent Contractor Services, the Commonwealth argued that the priority regime should apply to all of Amerind's assets, including trust assets.

What did the Court ultimately decide?

After distinguishing conflicting authority, the Court agreed with the reasoning in Independent Contractor Services and held that the priority regime did not apply to trust assets, such that the Commonwealth could not be paid in priority to other creditors – all creditors would be subject to the company's right to be indemnified from the trust assets and therefore share in the receivership surplus equally.

WHAT ARE THE IMPLICATIONS OF THESE DECISIONS?

These two decisions contradict long standing authority (and commercial wisdom) in relation to the application of the priority regime to trust assets. While there has been some criticism of this approach, it now appears to reflect the law in Australia.

Until any legislative amendment to section 433 is made, secured creditors will be able to recover the entirety of the proceeds of trust assets over which they hold a circulating security interest. This does not appear to be the intention of the statutory priority regime, nor does it reflect what the market has long considered should take place.

Reform is required. And quickly.

Footnotes

1 Landmark ruling on collapsed company a blow for taxpayers, Sarah Danckert, Sydney Morning Herald, 24 March 2017.

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