A long and winding road: Equitable subrogation of secured creditors to the rights of priority creditors

In the recent case of Blakeley, in the matter of Akron Roads Pty Ltd (in liq) [2020] FCA 1378, Justice Anderson in the Federal Court considered the question of when a secured creditor will be subrogated in equity to the priority rights of employees.

Background

The decision arose in the long running administration of Akron Roads Pty Ltd (Akron).

Akron was placed into voluntary administration on 1 February 2010, and then into liquidation on 9 March 2010.

Akron’s only secured creditor was Australia and New Zealand Banking Group (ANZ).  Akron owed ANZ over $13m, secured by two fixed charges and a fixed and floating charge over all of Akron’s assets and undertakings.

Akron also owed approximately $3.1m to employee creditors.

By 15 April 2011, the liquidators of Akron had realised the fixed charge assets and paid the proceeds to ANZ, reducing the ANZ debt to approximately $8.5m.  The liquidators also held net funds at that time of $1.5m, of which $1.2m had been realised from floating charge assets.

Given that the amount in hand was not sufficient to pay out the priority employee claims, the liquidators wrote to ANZ on 15 April 2011 seeking ANZ’s consent to make an interim distribution out of the floating charge asset proceeds to priority creditors pursuant to section 561 of the Corporations Act1 (Act).

The liquidators noted that ANZ might be able to claim a right of subrogation to the rights of the priority creditors paid from the floating charge asset proceeds.  ANZ agreed to the interim distribution on 16 May 2011 subject to an express reservation of ANZ’s right to seek to be subrogated to the rights of the relevant priority creditors.

The liquidators went on to pay $1.455m to the priority employee creditors (Interim Priority Distribution).

By the time of the application in 2020, the liquidators:

had applied recoveries from voidable transactions to pay the remaining employee priority claims in full; and

expected to recover a further amount of just under $2m from voidable transactions and insolvent trading claims that would be available for distribution to ANZ and the unsecured creditors of Akron (Further Liquidator Recoveries).

The application

The critical issue for the liquidators was that the Further Liquidator Recoveries were not caught by ANZ’s floating charge.  As a result, the only way ANZ could claim a priority entitlement to the Further Liquidator Recoveries was if ANZ was subrogated to the claims of the priority creditors that had been paid by the Interim Priority Distribution.

If ANZ was subrogated to these claims, it would have a priority entitlement to the relevant portion ($1.455m) of the Further Liquidator Recoveries and the unsecured creditors would receive a final dividend of 0.7c/$.  However, if ANZ was not subrogated to the claims of the priority creditors that had been paid by the Interim Priority Distribution, then the Further Liquidator Recoveries would be shared between ANZ and the unsecured creditors, and the dividend to unsecured creditors increased to 2.9c/$.

Given that ANZ had consented to the Interim Priority Distribution using the floating charge asset proceeds, the liquidators sought directions pursuant to section 90-15 of the Insolvency Practice Schedule that they were justified in regarding ANZ as subrogated to the priority rights of the employee creditors under section 556 of the Act in respect of the Interim Priority Distribution.

The liquidators also provided the creditors and ASIC with notice of the application and invited them to make objections to the application.  No concerns were raised by ASIC or the creditors of Akron.

The decision

Anderson J confirmed the well known principle that subrogation is the transfer of rights from one person to another without express assignment or assent, and that equitable subrogation will arise in circumstances where it would be unconscionable for the defendant to deny the proprietary right or interest claimed by the plaintiff.

Anderson J also noted that a similar question had arisen in Cook (Liquidator), in the matter of Italiano Family Fruit Company Pty Ltd (in liq) v Italiano Family Fruit Company Pty Ltd (in liq) [2010] FCA 1355, although that case had been decided on the basis of a breach of trust in that:

  • section 561 only requires liquidators to pay priority claims out of floating charge assets when it is clear that the liquidation would not realise sufficient free assets to pay those claims;
  • a liquidator holds the proceeds of sale of floating charge assets on trust for the secured creditor until the sufficiency of assets has been determined;
  • in that case, the liquidators used floating charge asset proceeds to pay priority claims before the sufficiency of assets had been determined, and ultimately recovered further assets of the company that could have been used to pay the priority claims;
  • Finkelstein J held that this was a breach of trust, and that the liquidators were therefore justified in treating the secured creditor as subrogated to the priority position of the employee creditors.

Anderson J confirmed that no breach of trust arose in this case as ANZ had consented to the Interim Priority Distribution, but went on to find that ANZ was entitled to equitable subrogation in any event as:

  • the intention of s556 of the Act is to prioritise the payment of employee entitlements in a winding up;
  • ANZ provided its consent to the Interim Priority Distribution in circumstances where it diminished its own security and Akron had insufficient free assets to make the payments;
  • further if ANZ had not provided its consent, payment of the Interim Priority Distribution would have been deferred, causing potential hardship to the employee creditors; and
  • given these matters, it would be unconscionable for “Akron” to enjoy a windfall and escape the liability discharged using the proceeds of ANZ’s floating charge assets.

Lavan comment

This is an important decision which extends the availability of equitable subrogation to circumstances where a secured creditor provides its express consent to an interim distribution to priority creditors using floating charge asset proceeds.

Given the first instance nature of the decision (and the implications of the Finkelstein J decision in the Italiano Family Fruit Company case), liquidators should carefully consider the sufficiency of assets question before making an interim distribution to priority creditors out of the proceeds of floating charge assets, and may wish to seek directions from the courts prior to making such an interim distribution.