Creditor Types and Ranking

Taking an interest in the liquidation of a company that owes you money may stand you in good stead to secure a better financial return.

The recent Australian Federal court case of Robinson, in the Matter of ACN 069 895 585 Pty Ltd (formerly known as Waterman Collections Pty Ltd) (in liq) [2013] FCA 706 highlighted the importance of creditors participating fully in the liquidation process rather than sitting on the sidelines and assuming the game is over.

So whether you’re an employee who is owed wages by a company in liquidation or a supplier seeking payment from an outstanding debtor on the brink of external administration, here is an overview of the rights and obligations of creditors in insolvency.

Types of Creditors

If a company owes you money, you are a creditor of that company.

Creditors are divided into two separate categories:

  • Secured
  • Unsecured

The question of who gets paid first when the debtor company becomes insolvent depends on their priority status as a creditor. The ranking or ‘priority’ of creditors will dictate the dividend in a winding up of the company or payable under a Deed of Company Arrangement (in the case of a voluntary administration).

Being aware of the primary differences between the types of creditors will assist creditors in understanding and engaging in insolvency processes for their own benefit.

Secured Creditors

A secured creditor is someone who has a security interest (as defined in s 12 of the Personal Property Securities Act 2009), such as a mortgage or a charge, over some or all of the company’s assets, to secure a debt owed by the company.

In the event that a company defaults on its obligations under a security interest, a secured creditor can appoint an independent, qualified receiver to take control of and realise some or all of the secured assets to satisfy the secured creditor’s debt. The assets must be sold at market value (or the best reasonably attainable price) .

A secured creditor is entitled to:

  • vote at creditors’ meetings for the amount the company owes them that exceeds the amount they are likely to receive from realisation of the secured assets;
  • participate in any dividend to unsecured creditors on a similar basis.

Unsecured Creditors

Unsecured creditors rank lower in priority than secured creditors as they have no ‘security’ over company assets. Unsecured creditors may include companies that sold goods or services to the company, ie, suppliers and the Australian Taxation Office.

If a company goes into liquidation, once a creditor has lodged a proof of debt, they will need to await the outcome of the liquidator’s investigations. If there are sufficient funds left in the liquidation after payment of liquidator’s fees and costs, and payment to priority creditors (ie, employees and secured creditors), the liquidator will distribute remaining monies to unsecured creditors as a dividend payment.

Each category of creditor is paid in full before the next category is paid. If there are insufficient funds to pay a category in full, the available funds are paid on a pro rata basis (and the next category or categories will be paid nothing). Unfortunately, there is no guarantee that creditors will get paid at all – in certain cases, there will be no money (or only a percentage) left in the pool to satisfy creditor claims.

Priority Unsecured Creditors

So what happens when an employee loses their job after their employer company becomes insolvent? Facing unemployment and the unlikely payment of outstanding entitlements is a daunting prospect for those who have been cast out after a company enters liquidation.

Employees can, however, take comfort in the fact that they are a special class of unsecured creditors with priority over other unsecured creditors to obtain employment entitlements.

Section 556 of the Corporations Act 2001 (Cth) (Act) lists the priorities for dividends in a liquidation including employee entitlement priorities. Generally, employees of the company have a statutory priority of payment with respect to outstanding entitlements (after payment of the costs and expenses of the liquidation, including liquidator fees) such as (in order of priority):

– wages and superannuation contributions

– personal injury compensation (if owing)

– leave entitlements, ie annual leave/holiday pay, personal leave (sick pay) and long service leave

– redundancy payments.

The only exception to this rule relates to ’excluded employees’. An excluded employee is someone who in the 12 months prior to the liquidation has been or is a director, spouse of a director or relative of a director. Excluded employees are subject to a priority cap of $2,000 for unpaid wage and superannuation entitlements and $1,500 for leave entitlements. The balance of entitlements will be treated at the same priority level as ordinary unsecured creditors.

Employees enjoy priority over the floating assets of the company (or those assets secured by ‘circulating security interests’) of secured creditors (s 561 of the Act).

Fair Entitlements Guarantee Act 2012

For employees who have lost their jobs when their employer company goes into liquidation, and the company has exhausted its funds or it will take a long time for liquidator to realise assets, the Federal Government also offers the Fair Entitlements Guarantee (FEG) legislative scheme (previously the General Employee Entitlements and Redundancy Scheme or GEERS). These schemes are managed by the Department of Employment (DOE).

Subject to eligibility requirements, the safety net scheme can offer funding relief by payment of leave entitlements, wages, payment in lieu of notice and redundancy entitlements (superannuation is not covered by this scheme).

FEG will operate in relation to employer liquidations and bankruptcies occurring after 5 December 2012 and GEERS will continue to operate in relation to insolvencies prior to 5 December 2012. Pursuant to s 560 of the Act, for any monies paid out by DOE under the GEERS and FEG schemes, DOE are granted the same priority as employees in the liquidation setting.

See our recent blog post on the FEG scheme.

Liquidation: Creditors’ Rights Generally

Once a company has entered into liquidation, creditors can often feel frustrated, uninformed or ‘out of the loop’ as if they have little control over the insolvency process and decisions that are made by the liquidator.

In a liquidation context, creditors should be aware that they have the right to:

  • submit a proof debt to the liquidator (with invoices and other supporting evidence to prove the existence of the debt)
  • ask the liquidator questions about the status of the liquidation and inform the liquidator about the creditor’s knowledge of the company’s affairs
  • provided they cover the costs, creditors may request that the liquidator call a creditors’ meeting at other times than as specified under the Act
  • vote at creditors’ meetings or appoint special or general proxies to attend and vote on the creditor’s instructions
  • receive written liquidation reports
  • inspect certain books
  • complain to ASIC or the court about the liquidator’s conduct.

Dealing with corporate insolvency as can be a confusing and complex process. As Insurance Australia Limited (IAL) discovered in the Robinson case, providing valuable information and litigation funding assistance and/or being actively involved may well lead to a better result at the end of the external administration process.

For more information on corporate insolvency or specific insolvency services, contact the team at Rapsey Griffiths on (02) 4929 3019 for a confidential consultation.