When a company enters a period of financial distress, cash flow is difficult to manage. Sometimes this means that third party funds are required to pay employee wages, superannuation contributions and other entitlements (leave and termination etc.) which result in the creation of a loan account.
In order to protect the funder in the event that the company goes into liquidation, there is a provision of the Corporations Act 2001 that may be useful to think about.
Section 560 of the Act operates to give the funder of employee entitlements the same rights as employees under the Act – i.e. the funder gets a priority over the claims of other creditors pursuant to section 556 of the Act. This is helpful because in the event of a dividend in liquidation, the funder ‘stands in the shoes’ of the employees and receives distributions ahead of the claims of ordinary unsecured creditors.
There are some important and critical issues to consider if this issue ever comes up that rise from the case law1 dealing with this matter:
- The funds must be lent to the company for on-payment to employees / superannuation funds and NOT paid directly by the funder
- The fund must be lent on the request of the company and not simply on a voluntary basis by the lender
- The loan must be recorded in the company’s records specifically as being for the purpose of paying employee entitlements (i.e. fully reconcilable) and not simply a generic lump sum
This provision is used by the Fair Entitlements Guarantee to protect is priority rights when making advances on behalf of terminated employees of companies that have gone into liquidation. Although a point of difference is that FEG pays funds directly to former employees with the consent and acknowledgement of the appointed Liquidator pursuant to a deed of undertaking.
So take care if this matter ever arises to ensure that the enhanced priority that is available under section 560 is protected.
Dalma No 1 Pty Ltd (In Liquidation) (ACN 111 772 260); Application of Bruce Gleeson and David Shannon in their capacity as joint and several liquidators and several liquidators of Dalma No 1 Pty Limited (in liquidation)  NSWSC 1335).
About the author
Greg Quin is a Director at HLB Mann Judd Insolvency WA and has been with the team for 10 years. Greg oversees the daily operations of the many insolvency appointments managed by the HLB Insolvency team and looks after the operations of the practice.
If you have any queries about insolvency matters, please feel free to contact Greg on 08 9215 7900, 0402 943 091 or via email to firstname.lastname@example.org.