Subrogation: A win for the secured creditor

Secured creditor recovers payment of statutory employee entitlements from liquidator in priority to unsecured creditors

Where a secured creditor appoints a receiver to assets of a company, section 443 of the Corporations Act 2001 provides that certain statutory employee entitlements must be paid to the company’s employees from the sale proceeds of a circulating security interest before any money is paid to the secured creditor from the proceeds.

Where the company is in liquidation, section 561 of the Act also requires specific statutory employee entitlements to be paid in priority to the secured creditor to the extent that there are insufficient available uncharged assets to pay specified statutory employee entitlements.

As a result, a secured creditor is at risk of receiving significantly less under its security.

Divitkos

The case of Divitkos, in the matter of ExDVD Pty Ltd (in liq) [2014] FCA 696 involved a receiver being appointed before the company went into liquidation. The receiver paid statutory employee entitlements of approximately $945,000, both before and after the date of liquidation.

There was a shortfall to the secured creditor under its security. The liquidator recovered unfair preferences creating proceeds (after costs) in the liquidation of approximately $1.4 million.

The secured creditor claimed it was entitled to $945,000 of the proceeds, being the statutory employee entitlements that had been paid by the receiver. The claim was based on the fact that the secured creditor’s security had been diminished by the amount of $945,000 as a result of the payments made by the receiver.

In Divitkos, the Federal Court held that the secured creditor was entitled to be subrogated in respect of the payments made by the receiver of the statutory employee entitlements. This meant the secured creditor was entitled to claim the amount of approximately $945,000 in priority to the unsecured creditors.

Why Divitkos is a win for secured creditors

The decision in Divitkos is a win for secured creditors because earlier court decisions have held that a charge over company assets does not attach to preference recoveries. Accordingly, proceeds recovered from preference recoveries have not been payable to the secured creditor under its charge.

In Divitkos, the secured creditor was able to recover the $945,000, not because the preferences were caught by its security, but because of the secured creditor’s right of subrogation. This right arose from the statutory employee entitlements having been paid from assets subject to the secured creditor’s security.

Implications

For a secured creditor whose receiver has paid statutory employee entitlements, the secured creditor should provide details to the liquidator of the statutory employee entitlements paid by the receiver. The secured creditor can lodge a proof of debt in the winding up for the amount paid.

The secured creditor who has paid statutory employee entitlements should not move on and forget once the company is placed in liquidation, but continue to monitor the conduct of the liquidation and, in particular, any preferences or other uncommercial transactions recovered by the liquidator.

The secured creditor’s right of subrogation will be subject to the liquidator’s equitable lien for the payment of the costs incurred by the liquidator in successfully recovering the preferences. This means the amount that the secured creditor will be able to claim by subrogation will be reduced by the costs incurred by the liquidator in successfully recovering the preferences.

The nature of a liquidator’s lien was considered in the recent High Court case of Stewart v Atco Controls Pty Ltd (in Liquidation) [2014] HCA 15 and was discussed in our legal bulletin published on 17 June 2014.

When recovering preferences, a liquidator will need to consider whether any secured creditor is entitled to be subrogated to and recover payment of statutory employee entitlements from the recovered preferences. This is something that should be disclosed when the liquidator is seeking any litigation funding to finance the proposed court action to recover preferences.

Any creditor proposing to fund a liquidator’s preference claim where there is a secured creditor entitled to be subrogated to the statutory employee entitlements will need to consider the terms of the proposed funding agreement with the liquidator. It is also suggested that the funding creditor should ensure the liquidator obtains the consent of the secured creditor to any proposal for the funding creditor to be given any priority over the secured creditor’s entitlement to be subrogated to statutory employee entitlements.

If you would like more information about these issues, please contact Graham Roberts or Sarah Dewar on +61 7 3231 2404.