Federal Court Clarifies Requirements of Section 561 of the Corporations Act

by K&L Gates LLP
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Overview

In Saker, in the matter of Great Southern Limited [2014] FCA 771 (Saker) the Federal Court considered the question of whether liquidators are trustees of funds said to be held for priority employee creditors, pursuant to section 561 of the Corporations Act 2001 (Cth) (Act). The Court found that no trust existed and directed the liquidators to treat the funds as funds to be applied in meeting the company’s unsecured debts in the order of priorities established by section 556 of the Act.

In reaching its finding, the Court did not follow the earlier Federal Court decisions in Cook Italiano Family Fruit Company Pty Ltd (in liq) (2010) 190 FCR 474 and Divitkos, in the matter of ExDVD Pty Ltd (in liquidation) [2014] FCA 696, in which similar funds were found to be held on trust.

This decision highlights the uncertainty faced by receivers and their appointers where it is unclear whether a company has sufficient property to meet the claims of priority unsecured creditors, including employee claims and the costs and expenses of administration and liquidation.

Background

In May 2009, receivers and managers were appointed to certain property of Great Southern Limited (GSL). Liquidators were subsequently appointed to GSL in November 2009.

Section 561 of the Act provides that, where the available property of the company is insufficient to meet the claims of former employees of the company, the former employees are to be paid in priority to the claims of secured creditors holding circulating security interests.

In November 2011, the receivers applied for directions from the Supreme Court of Western Australia in relation to how to comply with their obligations under section 561.

On 23 February 2012, the Supreme Court gave directions to the effect that, if the receivers were unable to determine whether there was sufficient company property available to meet employee claims, the receivers could set aside and hold on trust charged property sufficient to meet those claims. The Supreme Court also directed that, in the event the receivership came to an end, the funds set aside could be transferred to the liquidators, provided the liquidators also accepted the trust obligations.

The funds set aside by the receivers were transferred to the liquidators in February 2013.

By December 2013, the secured creditors’ claims were paid in full and the receivership was brought to an end. However, there were insufficient funds in GSL to meet all of the priority claims, including the costs of the liquidation, which, pursuant to section 556, have priority over the claims of former company employees.

In March 2014, the liquidators sought directions from the Federal Court as to whether:

  • any trust obligation existed in respect of the funds transferred to them by the receivers
  • the liquidators would be acting properly in applying those funds to meet the unsecured debts of GSL in the order or priorities established by section 556.

The Court's Judgment

The Court found that section 561 did not have the effect of making the receivers or the liquidators trustees of those funds.

The Court applied the reasoning in Visbord v Commissioner of Taxation (Cth) (1943) 68 CLR 354, in which the High Court noted that, if a person is bound by statute to apply money for the benefit of particular persons, that does not necessarily make him a trustee.

The Court directed that the liquidators would be acting properly in applying the funds to meet the unsecured debts of GSL in the order of priorities established by section 556 of the Act.

The Court did not consider whether the receivers had complied with section 561.  However, the Court suggested that the liquidators should consider whether there had been any non-compliance with section 561 and, if so, take appropriate action.

Impact of the Decision

This decision clarifies that, prior to retiring, receivers will need to ensure there are sufficient assets in the company to meet all unsecured priority claims, including employee claims.

In particular, where there are insufficient assets in the company to meet the costs of the priority creditors, receivers are at risk of having to disgorge sufficient assets to pay the balance owing to those priority creditors.

To avoid this risk, receivers should only set aside charged property to meet unsecured priority creditor claims when there is enough information to determine whether there are sufficient assets in the company to pay those priority claims.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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