Priority given to employees tempered against interests of general creditors and survival of the company

Where a company executes a deed of company arrangement (DOCA), for the most part, the Corporations Act 2001 (Cth) (CA) does not require creditors to be treated equally or that they are given the same priority as in a winding up.  There is one exception which is enshrined in section 444DA of the CA.  Section 444DA provides that a DOCA must contain a provision that employee creditors be given at least the same priority as in a winding up unless a majority otherwise agree, or the court permits, a departure from the rule.

The court's power to permit a departure from the rule is limited to the extent that 'it is satisfied that the non-inclusion of the provision would be likely to result in the same or a better outcome for eligible employee creditors as a whole than would result from an immediate winding up of the company'. Such an order was made by Finkelstein J in the recent case of Fitzgerald, Re Advance Healthcare Groups Pty Ltd (Administrators Appointed) [2008] FCA 1604.

In Fitzgerald the administrators conducted an investigation into the affairs of Advance Healthcare Groups Pty Ltd (AHG) and its trading subsidiary, Pharmeasy Pty Ltd.  They reached the conclusion that both companies were insolvent.  In particular, AHG had a shortfall of assets over liabilities that exceeded $8 million.  The creditors included Fulcrum Equity, which was owed $3.4 million, priority creditors (ie employees) who were owed approximately $377,740 and unsecured creditors whose claims totalled $7,430,687.

The administrators of AHG received from Romfal Corporate Pty Ltd, who acted on behalf of a syndicate of investors, a proposal that, if implemented, would have both AHG and Pharmeasy execute a DOCA that would see creditors' claims compromised and AHG relisted (Proposal).  In particular, the Proposal included a provision in the DOCA to the effect that the priority given to employee creditors would be limited to an amount equal to what they would receive under General Employee Entitlements and Redundancy Scheme (GEERS) plus an additional 10% (1).

For the Proposal to be implemented, it needed to be approved by the employee creditors or the court.  The Proposal was accepted by the general body of creditors, except the employee creditors who did not approve the Proposal on the basis that the DOCA did not give them the same priority as they would obtain in a winding up.  As a result, the court's approval was needed to accept the Proposal.

The court ordered that the Proposal should be approved on the basis that the financial position of AHG in a winding up was such that the employee creditors could not do better than what they might obtain under GEERS.  This was enough to satisfy s 444DA.  In making the order, Finkelstein J was of the view that Part 5.3A did not require creditors to be treated equally, nor did it require adoption of the priorities that applied in a winding up.  The main objective of Part 5.3A was to keep corporations 'alive'.  That objective is somewhat compromised by s 444DA if a company in difficult financial circumstances cannot be saved because priority must be given to its employees.  

This case shows that whilst, it has long been an objective of public policy to protect employee entitlements in the insolvency of the employer, the priority given to employee creditors must be weighed against the interests of the general body of creditors and what needs to be done to ensure the survival of a corporation.

If you have any queries in relation to this matter or any other insolvency matters, please do not hesitate to contact Alison Robertson on 9288 6872 or Stacey Porter on 9288 6719.

(1) GEERS is a scheme established by the Commonwealth in which money granted by Parliament is distributed to employees whose employment has been terminated because their employer is insolvent.  The entitlements covered by the scheme are unpaid wages, unpaid annual leave, unpaid long service leave, unpaid payment of notice and up to 16 weeks redundancy pay.
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