RSM Australia

Secured creditor’s right of subrogation confirmed

A recent decision in the Federal Court has confirmed that when a secured creditor has paid outstanding employee entitlements from the realisation of circulating assets, they have the right to subrogate into the position of employees and receive any dividends paid.

The Court in Weston (Liquidator); In the Matter of 7 Steel Distribution Pty Limited (in Liquidation) found that the secured creditor was entitled to lodge a proof of debt for employee entitlements paid pursuant to s433(3)(c) of the Corporations Act 2011 (“the Act”).

This right of subrogation is available even when the dividend is being paid from the proceeds of antecedent transactions.

The background

On 1 May 2010, HSBC Bank Australia Limited (“HSBC”) appointed Peter Marsden and David Kerr of RSM as Receivers and Managers of 7 Steel Distribution Pty Ltd and Paul Weston was appointed as Voluntary Administrator.  The company was subsequently placed into liquidation by resolution of creditors.

During the course of the receivership substantial recoveries were made on behalf of HSBC. Pursuant to s433(3)(c) of the Act, the receivers paid outstanding entitlements of $1.785 million to the employees of 7 Steel from the floating charge assets realised (now circulating assets under the PPS legislation).  The outstanding entitlements were paid in priority to any payments made to HSBC from these assets.

The case

Following the retirement of the receivers in December 2013, HSBC lodged a Proof of Debt in the liquidation consisting of 2 parts:

  1. The shortfall amount of $5.55 million
  2. The amount paid to employees pursuant to s433(3)(c) of the Act of $1.785 million

HSBC claimed the second amount as a priority debt.

The liquidator had been successful in recovering funds from unfair preference proceedings and made an application to Court for directions to determine whether he was justified in paying the amount of $1.785 million to HSBC in priority to unsecured creditors.

These directions were sought as in the ordinary course of a liquidation, secured creditors are not entitled to priority dividends from recoveries made from antecedent transactions, including unfair preference payments.

In their submissions, HSBC argued they had an equitable right of subrogation and were entitled to the same priority the employees would have received in the Liquidation.

The outcome

On the basis of 2 earlier decisions; Divitkos, in the matter of ExDVD Pty Ltd (in liquidation) and Currie, in the matter of Auto Electrical Distributors Pty Ltd (in liq) v Auto Electrical Distributors (Aust) Pty Ltd (in liquidation), the Court found that secured creditors have the right to subrogate where employee entitlements were paid by Receivers from circulating assets.  Further, the Court found that secured creditors are entitled to a dividend even if the funds available are a result of recoveries made from antecedent transactions.

HSBC’s Proof of Debt was admitted in the Liquidation and they will be paid the full amount of $1.785m.

Fair Entitlements Guarantee Recovery Programme

Just prior to this decision, the Commonwealth Government introduced the Fair Entitlements Guarantee Recovery Programme.  This programme is aimed at funding recovery action against directors, companies, secured creditors and receivers where employee entitlements are outstanding and unpaid due to the external administration of a company.

This programme is intended to improve the recovery of entitlements paid by the Department of Employment under the Fair Entitlements Guarantee (“FEG”) scheme.  It is also seeks to ensure receivers and secured creditors are complying with their duty to pay priority creditors from circulating assets.  The programme will hold receivers and secured creditors personally liable where there has been non-compliance.

The introduction of this programme highlights that compliance with s433(3)(c) is crucial for receivers and secured creditors, however, the decision in Weston (Liquidator); In the Matter of 7 Steel Distribution Pty Limited (in Liquidation) clarifies that secured creditors have the right of subrogation and are entitled to dividends even when recoveries are made from antecedent transactions.  

Key take-outs for secured creditors

  • Pursuant to s433(3)(c) of the Act receivers are obliged to pay outstanding employee entitlements from realisations made from circulating assets, ahead of secured creditors.
  • With the introduction of the Fair Entitlements Guarantee Recovery Programme there is now greater scrutiny on secured creditors and receivers to ensure they are complying with these obligations.
  • However, where employee entitlements are paid from circulating asset realisations, the secured creditor is entitled to subrogate the position of the priority creditors if the Company goes into Liquidation.
  • The decision in Weston (Liquidator); In the Matter of 7 Steel Distribution Pty Limited (in Liquidation) confirms that secured creditors are entitled to dividends where the funds to be paid have been recovered from antecedent transactions.  These are funds that would otherwise be unavailable to secured creditors.