When can a person (possibly a director or shareholder) of a company in liquidation obtain priority status as a creditor for loans to the company?
Section 560 of the Corporations Act 2001 (Cth) (the “Act“) provides that a person who advances funds to a debtor company, for the purpose of enabling that company to pay wages, leave, or retrenchment pay to its employees, is to have a priority creditor claim in respect of the amounts advanced.
The result is that if s 560 of the Act applies to the payments made to the company, the payer obtains rights to be subrogated to the priority position enjoyed by employees and will receive priority over ordinary unsecured creditors.
However, the priority provided by s 560 of the Act only applies to the extent that the employees would have had priority for payment of those entitlements, for which payment has been received from the payer, from the debtor company in a winding up.
Section 560 of the Act applies to payments received from any person, including directors and shareholders of the company. If the Commonwealth Government has paid employee entitlements under the Fair Entitlements Guarantee Act 2012 (Cth) they also assume the priorities of the employees just as a third party would.
In order to rely on s 560 of the Act the payer must be careful that the advances are paid in a manner strictly compliant with that section.
The key case in recent years is In the matter of Dalma No 1 Pty Limited (in liquidation) (ACN 111 772 260); Application of Bruce Gleeson and David Shannon in their capacity as joint and several liquidators of Dalma No 1 Pty Limited (in liquidation) and anor  NSWSC 1335 (17 September 2013) (“Re Dalma“).
Dalma No 1 Pty Limited (“Dalma“) was placed into liquidation. Dalma owed just over half a million dollars in employee entitlements. Ordinarily these types of debts attract priority in the winding up of a company, as per s 556 of the Act.
Dalma Constructions Pty Limited (“Dalma Constructions“) was a related entity of Dalma. Dalma Constructions made a number of voluntary payments directly to employees of Dalma for outstanding employee entitlements. Contemporaneously, Dalma Constructions wrote to the Administrators of Dalma and submitted that the payments to the employees of Dalma had been made pursuant to s 560 of the Act and subject to the condition that Dalma Constructions be afforded priority in any distribution of the assets of Dalma.
The question for the Court was whether Dalma Constructions was entitled to the right of subrogation provided for under s 560 in circumstances where Dalma Constructions had directly paid the entitlements to the employees of Dalma rather than advancing monies to Dalma on terms that those monies were to be used to pay the company’s liabilities to employees.
In support of its Application, Dalma Constructions sought to rely on the correspondence it had issued to the Administrators to the effect that the payments had been made to the employees on the condition that Dalma Constructions be afforded priority under s 560. This argument did not assist Dalma Constructions. On this point the Court found that the fact that the payments were made on a mistaken basis does not affect Dalma Constructions’ rights under s 560 of the Act.
The Court found that s 560 of the Act must be strictly complied with; commenting that [at 11] when invoking s 560, conformity with the “actual language and internal structure” of the provision is paramount.
Ultimately, the Court decided that Dalma Constructions did not “advance” monies to Dalma for purposes of s 560 of the Act. The reference in s 560(b) to an “advance” of money is to a loan to the company, which creates a debtor-creditor relationship [at 11]. Because the monies were not paid by Dalma Constructions to Dalma, but directly its employees, no debtor-creditor relationship was created and s 560 could not be relied upon.
Re Dalma demonstrates that in order for a person to be entitled to subrogation under s 560 of the Act, the advance must be paid in a manner compliant with the strict requirements set out under that section. When advancing money on the belief that certain rights will flow from that advance it is imperative that sound legal advice is obtained first, as the position for Dalma would have been different had the parties documented the transaction and directed the funds in a slightly different manner.