When a company is experiencing cash flow difficulties, directors will often loan money to the company to enable it to pay employee entitlements.
Should the company subsequently enter into external administration, having not repaid the abovementioned loan, the directors may be able to rely on protection, by way subrogation, should there be any return to creditors in the external administration.
The right of subrogation is discussed in section 560 of the Corporations Act 2001, which notes that a person who loans money to a company before or after an insolvency appointment commences, to pay for wages, superannuation and leave, will have the same rights to a priority payment as would an employee, had said employee not in fact been paid their entitlements by way of the loan.
The right of subrogation, as set out in section 560 of the Corporations Act 2001, is in fact relied upon by the Government when it makes payments to external administrators under the Fair Entitlements Guarantee (FEG) scheme, in respect of outstanding employee entitlements.
One must be aware, however, that there are some requirements which must be met to enable the right of subrogation and as such, priority status, to take effect. Such requirements include:
- Any funds being lent to the company must be paid directly to the company and not directly to the employee and/or superannuation fund;
- Any funds lent, must be at the request of the company and not voluntarily contributed by the lender; and
- Accounting of any funds lent must be explicit in its purpose (e.g. “loan to pay wages and superannuation for fortnight ending 12 December 2021”).
- Failure to comply with any of the abovementioned requirements will disqualify the lender from being able to rely on the right of subrogation to claim priority creditor status in any external administration.
Failure to comply with these strict requirements was evidenced in re Dalma No 1 Pty Limited (In Liquidation) and Anor  NSWSC 1335 (“Dalma”), with Brereton J interpreting section 560 of the Corporations Act 2001 as only applying to those payments ‘made by the company’ rather than ‘made by a company’.
In the Dalma case, a related party had, without any such request from the company, paid wages directly to employees rather than advancing the required funds to the company itself. Failure by the related party to (1) receive a request from the company for an advancement of funds and to (2) advance the funds directly to the company (to make payment to its employees) resulted in the related party being unable to rely on the right of subrogation to gain ‘priority creditor’ status in the external administration. Instead, the related party was only entitled to claim as an unsecured creditor for the advanced funds in the external administration.
The Dalma judgement clearly sets out that, for the right of subrogation to occur, the lender must transfer the funds directly to the company with instructions to pay the company’s wages, superannuation and/or leave.
If you are intending on loaning a company money to pay wages, superannuation and/or leave, ensure that it is accounted for correctly, so that, in the unfortunate event that the company enters into external administration, you are able to rely on the right of subrogation when pursuing repayment.
Should you have any concerns surrounding a loan which you have made to a company (for the purpose of paying employee entitlements), please contact our office for an obligation free discussion.
About the author
Benjamin Mitchell is a Senior Insolvency Accountant at HLB Mann Judd Insolvency WA. Benjamin assists the Partners with the many Corporate and Personal insolvency appointments managed by the HLB Insolvency team.
If you have any queries about insolvency matters, please feel free to contact the team on 08 9215 7900.