Bills Digest No. 125  1999-2000 Corporations Law Amendment (Employee Entitlements) Bill 2000


Numerical Index | Alphabetical Index

WARNING:
This Digest was prepared for debate. It reflects the legislation as introduced and does not canvass subsequent amendments. This Digest does not have any official legal status. Other sources should be consulted to determine the subsequent official status of the Bill.

CONTENTS

Passage History
Purpose
Background
Main Provisions
Concluding Comments
Endnotes
Contact Officer and Copyright Details

Passage History

Corporations Law Amendment (Employee Entitlements) Bill 2000

Date Introduced: 17 February 2000

House: House of Representatives

Portfolio: Treasury

Commencement: On Royal Assent

Purpose

The Bill will amend the Corporations Law in two ways. Firstly, it extends the duty on directors not to engage in insolvent trading to prohibit a company from entering into an uncommercial transaction that is not a debt.

Secondly, the Bill prohibits agreements and transactions entered into to prevent the recovery of employee entitlements.

Background

A number of corporate failures in recent years has focused public attention on the plight of employees who have had their entitlements threatened by corporate insolvency. Recent cases include the collapse of National Textiles in January this year, Braybrook Manufacturing in September 1999 and Oakdale Colliery in May 1999.

During 1999 over 7000 companies became insolvent. There are however, no statistics on the value of lost employee entitlements. While estimates made by the ACTU suggest that the cost of annual employee losses may amount to $140 million, the Benfield Greig Report, commissioned by the NSW Department of Industrial Relations, estimated that the figure was as high as $ 181 million.(1)

In the event of a corporate insolvency, secured creditors have first claim to a company's assets. Secured creditors are those that have a right to sell a specific asset in the event that a company cannot meet its obligations. A financial institution with a mortgage over the plant of a company is an example of a secured creditor. Employees however will generally be unsecured creditors. Unsecured creditors are not entitled to seek payment out of the sale of a specific asset. Under the Corporations Law, employees have high priority in a wind-up. Employees' entitlements rank ahead of unsecured trade creditors and the Tax Office but have a lower priority than the costs of the administrator or liquidator.(2) Under section 556, if money is available to pay employee entitlements it is paid in the following order: wages and superannuation contributions, injury compensation, leave entitlements and retrenchment payments.(3)

Unfortunately this high priority is sometimes insufficient to protect employee entitlements because company funds are exhausted in satisfying secured creditors.

Under Part 5.7B of the Corporations Law, a director of a company may be personally liable to creditors for corporate debts where the director has allowed the company to incur debts while insolvent. In order to establish a breach of the law it must be shown that the director knew that the company was insolvent or would be made so by the transaction (a subjective test) or that a reasonable person in a like position would have been so aware (an objective test). (4)A breach of section 588G can leave directors open to civil and criminal penalties as well as the payment of compensation.

In July 1999, the Minister for Financial Services and Regulation announced that the Ministerial Council for Corporations (MINCO)(5) had endorsed measures to strengthen the Corporations Law. MINCO agreed to proposals:

  • To introduce a new offence to stop directors from entering into arrangements or transactions that avoided payment of employee entitlements, and
  • To strengthen the existing prohibitions against insolvent trading so that directors would be breaking the law if they gave a financial benefit to a related party including an associated company - which lead to the company's insolvency. (6)

This Bill represents only one component of the Government's plan to address the issue. The Government has announced a national safety net scheme.(7) Analysis of this scheme is beyond the scope of this digest.(8)

While the State Ministers at MINCO accepted the Commonwealth's proposal, some argued that the amendments should go further. The NSW, Queensland and Tasmanian Governments argued in favour of:

  • expanding directors' personal liability for unpaid entitlements,(9)
  • setting up an institution to guarantee entitlements,
  • establishing a wage-earner protection fund, and,
  • requiring companies to pay superannuation contributions monthly.

The Western Australian Government argued that workers should have a higher priority to ensure that they got a proportion of their entitlements before secured creditors. Consideration of these proposals, some of which go beyond the scope of the Corporations Law, has been deferred.(10)

Main Provisions

Amendments to the Insolvent Trading Provisions

Item 3 amends section 588G which deals with the duty of a director to prevent a company from incurring a debt if it is insolvent or will be made insolvent by incurring the debt. Subsection 588G(1A) sets out a list of actions that are deemed to constitute incurring a debt for the purposes of the section. This list currently includes items such as paying a dividend, buying back shares and financially assisting a person to acquire shares. This item adds entering into an 'uncommercial transaction' to the list.

This term is already defined in section 588FB as a transaction that a reasonable person in the company's circumstances would not have entered into having regard to the benefits and detriment to the company of entering into a transaction and the respective benefits to other parties to the transaction. Other relevant factors can be taken into account in making this assessment. Such transactions are currently 'voidable' and a liquidator may apply to the court for an order that the financial benefit be returned so that it could be distributed to all creditors.(11) However there is no duty on directors not to engage in an 'uncommercial transaction' while the company is insolvent.

The effect of the amendment purposed by item 3 is that civil and criminal penalty provisions apply and directors may be personally liable. This amendment does not focus specifically on the protection of employee entitlements. It strengthens the law in a manner which could potentially benefit all creditors. However given the preferential priority given to employees under section 556, employees may benefit to a greater extent from the change than other creditors. While this amendment will tighten directors' duties, it should not be seen as a panacea for the problem of employee entitlements. Section 588G has been described as a 'paper tiger' as there have been few successful cases in the area.(12)

Item 4 inserts a new section 588N which is designed to ensure that a person is not subject to multiple penalties for the same conduct. Losses recovered under section 588M by a liquidator or creditor for insolvent trading are taken into account in working out the amount recoverable for a breach of new section 596AB (discussed below).

Employee Entitlements

Item 5 introduces a new part 5.8A which has the stated intention of protecting a company's employees from agreements and transactions entered into with the intention of defeating recovery of those entitlements (proposed section 596AA).

It is proposed that the employee entitlements protected by the amendments be the same as those that are given priority under section 556 of the Corporations Law namely:

  • Wages and superannuation contributions payable by the company,
  • Injury compensation,
  • Leave of absence due under an industrial instrument (e.g. long service leave and annual leave), and,
  • Retrenchment payments payable under an initial instrument. (proposed subsection 596AA(2)).

An industrial instrument is defined in section 9 of the Corporations Law to mean a contract of employment or a law, award or determination or agreement relating to the terms and conditions of employment. Leave of absence is also defined in section 9, it includes long service leave, extended leave, recreation leave, annual leave, sick leave or any other form of leave of absence from employment.

Entitlements are not limited to amounts that are owed to an employee. Funds owed to an employee's dependants are also included (proposed subsection 596AA(2)).

A limitation on the scope of 'employee entitlements' is provided by proposed subsection 596AA(3) which deals with 'excluded employees'. This term is defined in subsection 556(2) to include company directors, their spouses and relatives. Under section 556 they are limited to payments of $2000 in relation to wages and superannuation contributions, $1500 in relation to leave entitlements. Excluded employees are not entitled to priority in respect of retrenchment payments.(13) These restrictions are carried over into the new regime.

Proposed subsection 596AA(4) ensures that the definition of employee covers past and present employees of a company.

Proposed subsection 596AA(5) has the effect of deeming dependants of the employee to be employees.

Proposed section 596AB(1) is the central provision of the new part. It prohibits a person from entering into a relevant agreement or transaction with the intention or intentions that include:

  • preventing the recovery of entitlements of employees of a company, or,
  • significantly reducing the amount of the entitlements of employees of a company that can be recovered.

The subjective test required (ie the need to prove intent) would mean that it would be extremely difficult to bring a prosecution under this provision. As one commentator has noted:

Employees will need to prove not just that their entitlements are missing, but that the directors entered into arrangements with the purpose of ensuring that they would be unavailable.(14)

This issue will be discussed in more detail in the concluding comments section.

Proposed subsection 596AB(2)(a) states that subsection 596AB(1) applies even where the company is not a party to the agreement or transaction. The wording here is broad and will capture prohibited transactions arranged by non-related parties.(15)

The penalty for breach of proposed section 596AB(1) is a fine of $110,000 or imprisonment for 10 years (Item 6).

A person who has contravened section 596AB is liable to pay compensation to a liquidator or employees of the company under proposed section 596AC. In order for action to be brought a company must be in the process of being wound up and employees must be able to show loss from the breach of the section.

Therefore in situations where a company enters into a deed of arrangement, there will be no scope for either the liquidator or employees to bring an action to recover compensation for a breach of proposed section 596AB.(16) Of course, a criminal prosecution could be brought by ASIC under section 49 of the Australian Securities and Investment Commission Act 1989. However recent press suggests that ASIC will find it difficult to rigorously police the provision owing to a lack of resources. The insolvency profession has also been critical of ASIC's enforcement record in this area.(17)

A limitation period of six years applies in relation to action brought under proposed section 596AC (proposed subsection 596AC(4)).

Proposed section 596AD is aimed at preventing double recovery for the same conduct. Monies recovered in an action under proposed section 596AC are to be taken into account particularly in actions under section 588M for insolvent trading.

Proposed section 596AE is intended to clarify that the right to bring an action under section 596AC operates independently of any other right to bring an action in respect of a breach of duty.

The Explanatory Memorandum expresses the Government's desire to ensure 'that the orderly winding up of a company is not hampered by actions to recover employee entitlements'.(18) Proposed section 596AF therefore requires that an employee must seek the consent of the liquidator before commencing an action to recover compensation for a contravention of proposed section 596AB.

Proposed section 596AG states that an employee may give a liquidator written notice of his or her intention to bring an action for the breach of proposed section 596AB, and ask the liquidator to provide a written consent or provide a written statement of reasons within three months.

An employee may only give such a notice after the end of six months after the company has begun to wind up. These consent provisions are generally consistent with those in Part 5.7B in respect of creditors bringing actions for insolvent trading.

The Bill does provide for circumstances where an employee may sue for compensation even without the liquidator's consent. Under proposed section 596AH the Court may grant leave for an employee to bring proceeding if the liquidator has not consented at the end of three months.

Where a liquidator has given a statement of reasons indicating why proceedings should not be begun and the employee applies for leave of the Court, the employee must file this statement with the Court and the Court must take the liquidator's reasons into account when considering whether leave to take action shall be granted to the employee (proposed subsection 596AH(3)).

Proposed section 596AI presents a list of circumstances that prevent an employee from undertaking proceedings. These include:

  • Where a liquidator has applied to the Court for an order under section 588FF in relation to the transaction which forms part of the breach section 596AC. Section 588FF allows the Court to make orders about voidable transactions.
  • The liquidator has already commenced proceedings under section 596AC.
  • The liquidator has begun proceedings under section 588M. This section allows the liquidator to seek to recover from a director where there has been insolvent trading. The incurring of the debt must be linked to the breach of section 596AB.
  • The liquidator has intervened in a civil penalty order application in relation to section 588G. Section 588J provides that a company's liquidator may intervene in a civil penalty order on the question of whether a person who has breached section 588G should be liable to pay the company compensation. The breach of section 588G must be linked to the breach of section 596AC in order for an employee to be prevented from suing.

Concluding Comments

Director's Liability

The burden of proving subjectively that a person intended to avoid recovery of employee entitlements may mean that successful actions for compensation under section 596AC will be rare. If this occurs the deterrent effect of these amendments on the behaviour of directors will be greatly reduced.

It will be more difficult to prosecute a director for avoiding employee entitlements under proposed section 596AB than to bring an action for insolvent trading under section 588G.

In a criminal prosecution against a director for insolvent trading under section 588G it is necessary to show that the director contravened the section knowingly, intentionally or recklessly and was dishonestly intending to gain or defraud someone.(19) However in order to recover compensation under section 588G it is not necessary to prove that a director knew that the company was insolvent. An objective test applies and it is sufficient if the company incurs a debt while insolvent or becomes insolvent as a result of incurring a debt and there were reasonable grounds for suspecting that the company may be or become insolvent.(20)

The policy justification for requiring a more onerous evidentiary burden in compensation cases where it is alleged that a director has sought to avoid paying employee entitlements than in cases of insolvent trading is not clear.

Other jurisdictions impose liability on directors for non-payment of workers' entitlements without requiring proof of intent. For example the Industrial Relations Act 1999 (QLD) provides that directors may be liable for a failure to pay an employee's wages or failure to contribute to occupational superannuation as required by the relevant industrial instrument.(21) It is a defence if the director can prove that they exercised 'reasonable diligence' to ensure that the corporation complied with the section. Canadian jurisdictions have similar legislation.(22)

The NSW Attorney-General proposed that company directors could be held personally liable where for example, a director has not acted with due diligence to make provision for the payment of accrued entitlements (that is wages, leave, injury compensation but not retrenchment entitlements). The requirements of due diligence could be satisfied:

where the corporation has provided for the payment of wages due and owing by way of a trust fund, a wage guarantee fund, or has otherwise taken out appropriate and adequate insurance where such a mechanism is successful in quarantining and paying employee wages due and owing. It would not be sufficient to merely deposit money in an account, as it would be exposed to claims by other creditors. The effect of such a provision may be to provide an incentive to company directors to arrange adequate insurance or take other action to ensure the security and payment of entitlements. (23)

Opponents of extending directors' liability caution against 'lifting the corporate veil'. Companies are separate legal identities; directors and others who establish a company have the benefit of limited liability. It is argued that limited liability promotes entrepreneurial behaviour which, if successful can lead to job growth. In order to preserve these benefits 'piercing the corporate veil should be reserved for cases of deliberate fraud.'(24) Any attempt to extend Directors' liability must be balanced against the need to ensure that the law does not deter legitimate enterprise.

Enhanced Priority for Employees?

This Bill does not alter current priority arrangements. Some have argued however that secured creditors are often in a better position than employee to protect their own interests and that employee claims should be placed ahead of secured creditors.(25) The Australian Institute of Company Directors (AICD) has stated that accrued benefits should have priority over secured creditors. According to the national president and chief executive of the AICD:

While this proposal may have some adverse implications with regard to capital raising, companies and their financiers would adjust. It would also introduce greater discipline into bank lending and credit practices.(26)

The Government has opposed proposals to increase the priority of workers entitlements at the expense of secured creditors. The Minister for Workplace Relations expressed concern that such a move would increase the risk of lending, leading to an increase in lending costs and interest rates.

This would adversely affect all business, especially small businesses. Further it may increase the likelihood of lenders foreclosing at an earlier stage to protect themselves.(27)

Any move to downgrade priority of secured creditors would represent a fundamental change in the nature of business lending for financial institutions. The ramifications of any move to increase employee priority would need to be carefully considered.

Endnotes

  1. For a critical appraisal of these estimates see The Hon. Peter Reith MP, 'The Protection of Employee Entitlements In The Event Of Employer Insolvency', Ministerial Discussion Paper, August 1999, p. 6-7.

  2. See Corporations Law Section 556.

  3. Employees entitlements also take priority over floating charges see section 561. A floating charge is a form of security not involving specific piece of property. It is a general charge over the assets of a company granted by a company to a lender. Events such as the appointment of a receiver will crystallise the charge, meaning that the charge will then become a fixed or specific charge.

  4. See Corporations Law subsection 588G(2).

  5. Under the terms of the Corporations Agreement, the consent of the States is required to amend the Corporations Law.

  6. The Hon. Joe Hockey, Minister for Financial Services and Regulation, 'Government Unveils Measures To Protect Employee Entitlements', Press Release, 22 July 1999.

  7. For details of this scheme, The Hon. Peter Reith MP, 'National Scheme to Protect Employee Entitlement', Media Release, 8 February 2000.

  8. For an analysis of some of the broader issues surrounding the protection of workers' entitlements see Roza Lozusic, 'Workers Entitlements and Corporate Insolvency', NSW Parliamentary Library Research Service, Briefing Paper, No.17/99.

  9. This proposition was also supported by the Victorian Government.

  10. Stephen Long, 'Push to Secure Employee Benefits', Australian Financial Review, July 23 1999.

  11. Corporations Law section 588FF .

  12. Christopher F Symes, 'Do not Dismiss the Employee as a Statutory Priority Creditor in Corporate Insolvency', Australian Business Law Review, v.26, 1998, p 461.

  13. These restrictions only apply to 'non-priority days'. For example entitlements accrued by aperson prior to his/her appointment as a director of the company will have priority.

  14. Chris Merritt, 'How business will pay the price', Australian Financial Review, 12 February 2000.

  15. The Hon. Joe Hockey, Second Reading Speech, House of Representative, Debates, 17 February 2000, p. 13637.

  16. This limitation is consistent with the situation in relation to actions to recover damages for a breach of the insolvent trading provisions or an action in relation to a voidable transaction. These actions cannot be maintained once a deed of arrangement has been concluded.

  17. Toni O'Loughlin and Joseph Kerr, 'Breaches to escape wrath of the Law', Sydney Morning Herald, 28 February 2000.

  18. Explanatory Memorandum, p 6.

  19. Corporations Law section, 1317FA.

  20. In addition, it is important to remember that, unlike proposed section 596AB, section 588G is a civil penalty provision. The standard of proof in proceedings for a civil penalty order is the balance of probabilities rather than the criminal standard of beyond reasonable doubt. An application for a civil penalty order may only be made by ASIC, its delegate or another person authorised by the Minister (section 1317EB). A liquidator may however intervene in a civil penalty proceeding and seek an order for compensation (section 588J). The Court may order that a person be prohibited from managing a corporation and that the person pays a pecuniary penalty to the Commonwealth of $220,000.

  21. See section 673 of the Industrial Relations Act 1999 (Qld).

  22. Canada Business Corporations Act, section 119, Employment Standards Act, section 96 (British Columbia). Directors are liable for 'wages', however, in some cases this includes annual leave and amounts payable to pension funds on the employees behalf. At a Federal level, directors are liable for up 6 months wages. In Britsih Columbia,the limit is two months.
    See also I. Christie, G. England, and B.Cotter, Employment Law in Canada, 2nd Ed.Butterworths p 840-1.

  23. The Hon. J. Shaw QC, MLC, 'The Protection of Employee Entitlements', Paper given to the Australian Centre for Industrial Relations Research and Training Conference, 16 July 1999, Sydney. It has been reported that a trust fund of the kind alluded by Mr Shaw is already operating in the Victorian cleaning industry. The fund is jointly managed by employer and employee representatives. See Kenneth Davidson, 'Put free riders on employee entitlements out of business', The Age, 17 February 2000.

  24. Christopher F Symes, 'Do not Dismiss the Employee as a Statutory Priority Creditor in Corporate Insolvency', Australian Business Law Review,v.26, 1998, p.462.

  25. Australian Council of Trade Unions, 'Unions call for legal protection of employee entitlements, and examine trust funds', Media Release, 16 July 1999.

  26. Dick Warburton and Ian Dunlop, 'Why we must accept failure', The Australian, 29/2/2000.

  27. The Hon. Peter Reith MP, The Protection of Employee Entitlements In The Event Of Employer Insolvency, Ministerial Discussion Paper, August 1999 p.7.

Contact Officer and Copyright Details

Mark Tapley
3 March 2000
Bills Digest Service
Information and Research Services

This paper has been prepared for general distribution to Senators and Members of the Australian Parliament. While great care is taken to ensure that the paper is accurate and balanced, the paper is written using information publicly available at the time of production. The views expressed are those of the author and should not be attributed to the Information and Research Services (IRS). Advice on legislation or legal policy issues contained in this paper is provided for use in parliamentary debate and for related parliamentary purposes. This paper is not professional legal opinion. Readers are reminded that the paper is not an official parliamentary or Australian government document.

IRS staff are available to discuss the paper's contents with Senators and Members
and their staff but not with members of the public.

ISSN 1328-8091
© Commonwealth of Australia 2000

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Published by the Department of the Parliamentary Library, 2000

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