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Court confirms secured creditor's rights of subrogation for employee priority creditors

CaseFlash 27 July 2015

The recent Federal Court decision of Weston (Liquidator); In the Matter of 7 Steel Distribution Pty Limited (in Liq) [2015] FCA 742 (7 Steel) held that the liquidator was justified in seeking directions and determined that the secured creditor should be paid in priority to unsecured creditors in circumstances where its interest was diminished by employee payments made pursuant to s433(3)(c) of the Corporations Act 2001 (the Act).

On 1 March 2010, HSBC Bank Australia Limited (HSBC), the secured creditor of 7 Steel, appointed administrators under s436C of the Act and receivers and managers. 7 Steel subsequently went into liquidation and the administrators were appointed as liquidators of 7 Steel.

The liquidator of 7 Steel made an application for directions to the Federal Court after HSBC lodged a proof of debt for $7,332,605. HSBC’s proof of debt comprised 2 amounts:

  1. $5,547,571 which represented the shortfall following the realisation of its security by the receivers. HSBC claimed this amount as an unsecured debt in the winding up of 7 Steel;
  2. $1,785,034 which was claimed as a priority debt and represented the sum the receivers paid to employees of 7 Steel in accordance with their obligations under section 433(3)(c) to priority creditors.

The liquidator asked the Court to provide a direction that it was justified in making the priority payment to HSBC in circumstances where if priority was given to HSBC’s claim, the amount of the dividend payable to the unsecured creditors of 7 Steel would be significantly diminished. Justice Foster noted that the unsecured creditors were aware of the liquidator’s application before him and there was no appearance by or on behalf of any creditor.

The Judge agreed that the $1,785,034 paid to the employees of 7 Steel by the receivers gave HSBC an equitable right of subrogation over the remaining funds in the liquidation and the liquidator was therefore justified in paying HSBC the amount of $1,785,034 in priority to the claims of the unsecured creditors.

The Court was also satisfied that it was appropriate to give the direction sought pursuant to s511 of the Act. The costs of the application were ordered to be costs in the winding up.

This decision closely followed the introduction of the Fair Entitlements Guarantee Recovery Programme on 1 July 2015 (Recovery Programme). Under the Recovery Programme, the Government will provide $11.5 million over two years from 2015-2016 to undertake a two year trial of funding litigation activities to improve the recovery of employment entitlements advanced under the Fair Entitlements Guarantee (FEG) scheme.

Under FEG, if a company goes into liquidation, the Government provides assistance to cover certain unpaid employment entitlements to eligible employees early in the liquidation process before all assets and company funds are realised and then recovers its costs once the litigation process is complete.

Through the introduction of the Recovery Programme, the Government is seeking to fund liquidators to enable recovery efforts, including legal proceedings, which the liquidators would not otherwise have the financial resources to pursue. There is an emphasis on reducing phoenix activity and ensuring that receivers have fulfilled their statutory duty under s433(3)(c) to pay employee entitlements before paying the proceeds of the secured property to their appointor.

The decision in 7 Steel confirms the position that if the secured creditor does pay employee entitlements, they will be subrogated to a priority position in the event of liquidation.

Kirsten Farmer, Partner

Helene Roins, Senior Associate

CaseFlash 27 July 2015
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