Bills Digest No. 50, Bills Digests alphabetical index 2018–19

Corporations Amendment (Strengthening Protections for Employee Entitlements) Bill 2018

Treasury

Author

Jaan Murphy

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Introductory Info Date introduced: 20 September 2018
House: House of Representatives
Portfolio: Treasury
Commencement: The day after the Act receives the Royal Assent.

The Bills Digest at a glance

Why the Bill has been introduced

  • The deliberate use of ‘sharp corporate practices’ (including ‘phoenixing’) to prevent or reduce recovery of employment related entitlements during a corporate insolvency is viewed as inappropriately shifting the cost of employee entitlements onto Australian taxpayers through utilisation of the taxpayer funded Fair Entitlements Guarantee scheme (FEG).

What the Bill does

  • The Bill aims to strengthen the protections provided for the recovery of employee entitlements in insolvency by:
    • deterring and penalising entering into or facilitating agreements or transactions to prevent or avoid the recovery of, or significantly reduce the amount that can be recovered of, those entitlements
    • allowing contributions to be sought from certain entities in a corporate group, or entities with a closely connected economic relationship, for the payment of outstanding employee entitlements of an insolvent company and
    • allowing the disqualification of company directors and other officers with a track record of involvement in corporate contraventions and insolvencies, where the FEG scheme has been inappropriately relied on.

Key issues

Key issues raised by the Bill include:

  • a lack of a due diligence defence
  • types of entities that have standing to commence proceedings
  • the circumstances in which entities can be ordered to contribute to the cost of the employee entitlements of another entity and
  • retrospective application of the disqualification regime to conduct that occurred before the commencement of the proposed amendments.

Purpose of the Bill

The purpose of the Corporations Amendment (Strengthening Protections for Employee Entitlements) Bill 2018 (the Bill) is to amend the Corporations Act 2001 (the Act) and the Corporations (Aboriginal and Torres Strait Islander) Act 2006 (the Aboriginal Corporations Act) to deter behaviours by companies and directors aimed at preventing, avoiding or significantly reducing the recovery of employment related entitlements during a corporate insolvency. This is because such behaviours shift the cost of employee entitlements onto Australian taxpayers through utilisation of the taxpayer funded Fair Entitlements Guarantee scheme (FEG).[1] The Bill aims to deter such behaviours by:

  • strengthening enforcement and recovery options and
  • introducing new provisions that will facilitate the disqualification of company directors and other officers where they have a track record of corporate contraventions and inappropriately using the FEG scheme to pay outstanding employee entitlements during a corporate insolvency.[2]

Structure of the Bill

The Bill has one Schedule, divided into four Parts:

  • Part 1 seeks to amend the Act to strengthen the protections provided for the recovery of employee entitlements in insolvency, with a view to deterring and penalising parties entering into or facilitating agreements or transactions to prevent or avoid the recovery, or significantly reduce the amount that can be recovered, of those entitlements.
  • Part 2 seeks to insert new provisions into the Act that allow contributions to be sought from certain entities in a corporate group, or entities with a closely connected economic relationship, for the payment of outstanding employee entitlements of an insolvent company
  • Part 3 seeks to amend the Act to allow the disqualification of company directors and other officers with a track record of involvement in corporate contraventions and insolvencies, where the FEG scheme has been inappropriately relied on and
  • Part 4 contains transitional provisions related to the above.

Background

The context to the Bill is the use of ‘sharp corporate practices’ – including phoenixing – to prevent, avoid or reduce the payment of company debts to creditors prior to a company being liquidated, which in turn increases reliance on the FEG and hence costs to the taxpayer.

Liquidation of companies and phoenix activity

Often when a company becomes insolvent, it ends up being liquidated. The terms ‘solvency’ and ‘insolvency’ are defined in section 95A of the Act as follows:

1. a person is solvent if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable and

2. a person who is not solvent is insolvent.

As such, a company will be insolvent when it cannot pay all its debts as and when they become due and payable.

In this digest the terms ‘winding up’ and ‘wound up’ refer to liquidation. Liquidation is a form of external administration under which the company’s affairs are ‘wound up’, its property sold, debts owed to creditors repaid (in full or in part) and the surplus (if any) distributed amongst its shareholders. As such, liquidation ultimately results in the company ceasing to exist as a legal entity.[3] Often a liquidation results in creditors not being repaid in full – and this can include employee entitlements.

As noted in the Explanatory Memorandum, certain ‘sharp corporate practices’ are adopted by some company representatives, company owners, pre-insolvency advisers, or other parties involved in corporate transactions, to prevent, avoid or reduce the payment of obligations to creditors (including employees and other creditors such as the Australian Taxation Office (ATO)) prior to a company being liquidated.[4] Importantly, sharp corporate practices include ‘phoenix activity’ which can be broadly defined as activity involving:

... the transfer of assets from an existing company to a new company without paying market value, before placing the first company in liquidation. The same business is continued under the new company, leaving any debts (such as taxes, amounts owing to creditors and employee entitlements) with the existing company, which is liquidated. Whilst not all phoenix activity is unlawful, what separates a legitimate business rescue from illegal phoenix activity is the business operators’ aim to avoid paying debts and liabilities of the company.[5]

Impact of phoenix and other sharp corporate practices on the FEG

The Commonwealth Government operates FEG. The FEG aims to assists certain employees when their employer’s business fails and the employer has not made adequate provision for employee entitlements (such as accrued leave, redundancy payments and unpaid wages). It was designed to be a scheme of ‘last resort’ to support workers made redundant during corporate insolvency.

The use of phoenixing and other sharp corporate practices to attempt to avoid paying creditors and their impact on the FEG is central to the Bill. As noted in the Treasury consultation paper:

Costs under the FEG scheme have dramatically increased with FEG payments totalling more than $1 billion between 2012-13 and 2015-16. This represents a 75 per cent increase over the preceding four year period. There is increasing evidence that some employers are deliberately structuring their corporate affairs to avoid paying employee entitlements when a business becomes insolvent. In several recent cases, practices have been openly employed to shift the cost of the employee entitlements to the FEG scheme.[6]

In this regard, the Explanatory Memorandum notes that average annual costs under the FEG scheme have more than tripled from $70.7 million in the four year period between 1 July 2005 and 30 June 2009, to $235.3 million in the four year period between 1 July 2014 and 30 June 2018 and

... it is important to note that the costs imposed on the FEG scheme from just a few select instances, by those attempting to avoid their employee entitlement payment obligations through using sharp corporate practices, equated to more than $100 million of taxpayer funded money in the last few years.[7]

The Government views the inappropriate reliance by some employers on the FEG scheme to cover the payment of employee entitlements as unacceptable, especially in circumstances where businesses can pay their employee entitlements but choose not to.[8] As noted by Treasury:

The existence of the FEG scheme presents a moral hazard as it enables certain employers to arrange their affairs to prevent, avoid or minimise paying their employee entitlements with the knowledge that the government (and ultimately the taxpayer) will pay some or all of the entitlements.[9]

To address those concerns, Treasury released a consultation paper in May 2017, followed by draft legislation from June 2018.[10] The Bill is the outcome of those consultation processes.[11]

Historical evolution of the Fair Entitlements Guarantee scheme

In response to a number of significant corporate insolvencies which left employees with unpaid entitlements, and public concern about the lack of protections for such entitlements, the Commonwealth Government established the first assistance program to protect employee entitlements in January 2000. It aimed to provide a national safety net for the protection of entitlements of employees whose employment was terminated because of corporate insolvency.[12]

Those key features have underpinned all successive Commonwealth government employee entitlement schemes.[13] In effect, these schemes – including the FEG – signalled the Commonwealth Government’s acceptance:

... that the taxpayer would ‘insure’ employees for their unpaid employee entitlements (including redundancy pay) in the event of their employer’s insolvency.[14]

The Fair Entitlements Guarantee Act 2012 (FEG Act) was enacted in 2012 and gave legislative effect to the key principles underpinning the FEG scheme and its predecessor administrative schemes, namely:

  • employers should be responsible for meeting employee entitlements and
  • the FEG scheme is a scheme of last resort, where no alternative avenue exists for eligible employees to be paid their accrued employment entitlements or redundancy pay due to the insolvency of their employer.[15]

The FEG scheme provides financial assistance (by way of an advance) to cover five basic employment entitlements for redundant employees being:

  • unpaid wages (up to 13 weeks)
  • annual leave
  • long service leave
  • payment in lieu of notice (up to five weeks) and
  • redundancy pay (up to four weeks per full year of service).[16]

Once a payment (the ‘advance’) is made to a redundant worker under the FEG scheme the Commonwealth Government ‘steps into the shoes’ of the employee, and hence has standing to recover the amount of FEG advanced to the worker through the insolvency process (usually from the company being liquidated).[17] This is why the payments are referred to as an ‘advance’: the Commonwealth effectively ‘advances’ the entitlements to the employees, then seeks to recover them in the liquidation process.[18]

As a safety net for the payment of employee entitlements, the costs of the FEG scheme are ultimately borne by taxpayers. This includes meeting costs associated with misuse of the scheme.

Committee consideration

At the time of writing the Bill had not been referred to any Committee for inquiry and report.

Senate Standing Committee for the Scrutiny of Bills

The Senate Standing Committee for the Scrutiny of Bills discussed aspects of the offence-specific defences proposed by the Bill.

The Committee noted that at common law, it is ordinarily the duty of the prosecution to prove all elements of an offence. This is an important aspect of the right to be presumed innocent until proven guilty. As such, provisions that reverse the burden of proof and require a defendant to disprove, or to raise evidence to disprove, one or more elements of an offence, interfere with this common law right.[19]

The Committee noted that subsection 13.3(3) of the Criminal Code Act 1995 provides that a defendant who wishes to rely on any exception, exemption, excuse, qualification or justification bears an evidential burden in relation to that matter.[20] The Committee also noted that a matter should only be included in an offence-specific defence (as opposed to being specified as an element of the offence), where:

  • it is peculiarly within the knowledge of the defendant and
  • it would be significantly more costly for the prosecution to disprove than for the defendant to establish the matter.[21]

The Committee noted that the amendments proposed by the Bill result in the defendant bearing an evidential burden (requiring the defendant to raise evidence about the matter), rather than a legal burden (requiring the defendant to positively prove the matter). In that context the Committee noted:

... while the committee acknowledges that the defendants may be able to raise evidence in relation to the matters in proposed subsections 596AB(2B) and (2C) (such as whether a compromise or agreement was approved by a court, entered into under a [deed of company arrangement] DOCA or in the course of winding up), it is unclear that those matters would be peculiarly within the defendants’ knowledge, such as to make it appropriate to reverse the burden of proof.[22]

The Committee then drew its scrutiny concerns to the attention of Senators, and noted it was for the Senate as a whole to consider:

... the appropriateness of reversing the evidential burden of proof in proposed subsections 596AB(2B) and (2C), in circumstances where the matters do not appear to be peculiarly in the defendants' knowledge.[23]

Policy position of non-government parties/independents

The Opposition appears to support the Bill, but has flagged an intention to move certain amendments, with Brendan O’Connor, Shadow Minister for Employment and Workplace Relations stating:

Labor is pleased to see this bill come onto the agenda. The reforms in the bill are sensible and, in some cases, the bill adopts announced Labor policy... we support the introduction of this bill and we do support the fact that there was some sensible consultation... Labor believes this bill could be improved to give registered organisations standing to commence civil proceedings, as they currently have under the Fair Work Act, and standing to make applications for compensation on behalf of the employees they represent. Where a union is entitled to represent the industrial interests of an employee or group of employees, they should have standing to represent those people to assist them in obtaining compensation for loss of entitlements. We have informed the government that it's our intention to move amendments in the Senate to make these improvements, and we do hope to receive the government's support. I've had discussion with the minister and the minister's office, and I believe, in those conversations more broadly about this and other matters contained in the portfolio, that the minister was open, at least, to engaging with the opposition and reconciling the differences between the opposition and the government wherever possible. I say that sincerely. We do hope we can engage on more substantive amendments that we moved in the other place that would look to improve this bill to strengthen the protections for employees, to ensure that we can go after those directors who deliberately seek to effectively steal public moneys by using a scheme designed for companies that collapse, not ones that are contrived in a manner to avoid obligations to creditors or, in this case, to employees. So, whilst I won't be so naive as to think that we can reach agreement on all of these matters, we will go into the negotiations with the government with respect to the amendments we'll be moving in the Senate with a view to finding common ground to improve this bill.[24]

Based on comments made in the second reading debate in the House of Representatives, it appears that the Greens and Bob Katter support the policy intent of the Bill.[25] Centre Alliance member, Rebekha Sharkie has also indicated her support for the Bill.[26]

At the time of writing, the position of other non-government parties and independents regarding the specific measures contained in the Bill could not be determined.

Position of major interest groups

As noted above, a consultation regarding the measures proposed by the Bill was conducted by Treasury in May 2017, followed by draft legislation and associated consultations from June 2018.[27] The Bill is the outcome of those processes.[28]

Due to the length of time the overall consultation process has taken, and the changes between the exposure draft and the Bill there is a risk that views of major interest groups may have changed over the course of time. As such this Digest does not examine the position of major interest groups in detail.

However, most submissions to the exposure draft consultation process were generally supportive of the overall policy intent on the Bill, with some submissions raising issues about specific measures or providing drafting suggestions.[29] Only the Housing Industry Association (HIA) appears to have opposed the exposure draft on the basis that ‘the proposals unjustifiably expand the reach of the current provisions’.[30]

Financial implications

The Explanatory Memorandum notes the proposed reforms will have no financial impact on the Commonwealth.[31] However, according to the Bill’s Explanatory Memorandum there will be:

... one-off education costs on the wider business community related to the reforms. These have been estimated at $150,000 on an annualised basis.[32]

Statement of Compatibility with Human Rights

As required under Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 (Cth), the Government has assessed the Bill’s compatibility with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of that Act. The Government considers that the Bill is compatible.[33]

Parliamentary Joint Committee on Human Rights

The Parliamentary Joint Committee on Human Rights considered that the Bill did not raise any human rights concerns.[34]

Key issues and provisions: deterring avoidance of employee entitlements

Current law – criminal liability for avoidance of employee entitlements

Under existing laws it is a criminal offence for persons to enter into a relevant agreement or transaction with the intention of, or with intentions that include the intention of, preventing the recovery of, or significantly reducing the amount that can be recovered of, a company's employee entitlement liabilities.[35] Due to the operation of the Criminal Code Act 1995, accessories to such offences are captured.[36]

The Explanatory Memorandum notes that since its introduction in 2000, there have been no successful criminal prosecutions under the current criminal offence provision.[37]

Current law – civil liability for avoidance of employee entitlements

Currently a company liquidator can bring a civil compensation action against persons – such as company directors – to recover an amount equal to the loss or damage incurred (in this case, employee entitlements), however such actions operate in conjunction with the criminal offence provision.[38] In addition, with the consent of the liquidator (or with the leave of the Court) civil compensation proceedings can be brought by former employees against a person who intentionally entered into arrangements to avoid paying employee entitlements.[39]

The Explanatory Memorandum notes that since their introduction in 2000, there have been no successful civil recovery actions under the current provisions.[40]

What types of entitlements are captured by the offence provisions?

Proposed subsection 596AA(2A) specifies that employee entitlements need not be owed directly to an employee of a company to still be within scope of the protections provided (and hence the offence provisions). It provides examples of such indirectly-owed employee entitlements, including:

  • an amount owed to the employee’s dependants (for example, amounts an employee has compulsorily deducted from their salary to satisfy child support obligations)
  • a superannuation contribution payable to a fund in respect of services rendered by the employee (for example, compulsory superannuation contributions payable by the employer deducted from the employee’s salary but not remitted to a superannuation fund)
  • a right in relation to an entitlement that becomes a right of the Commonwealth under paragraph 31(1)(b) of the FEG Act[41] or
  • an entitlement in relation to which an entity other than the employee has a right of subrogation.[42]

Extending criminal liability for avoidance of employee entitlements

The Bill provides that it is an offence for a person (including an officer of a company) to enter into a relevant agreement or a transaction:

  • with the intention of (or with intentions that include the intention of):
    • avoiding or preventing the recovery of the entitlements of employees of a company or
    • significantly reducing the amount of the entitlements of employees of a company that can be recovered,[43]
  • reckless as to whether the relevant agreement or the transaction will:
    • avoid or prevent the recovery of the entitlements of employees of a company or
    • significantly reduce the amount of the entitlements of employees of a company that can be recovered.[44]

Recklessness as a fault element

The amendments extend the applicability of the offence by using both intention and recklessness as fault elements. The Criminal Code Act provides that a person is ‘reckless’ with respect to a result if they are aware of a substantial risk that the result will occur and, having regard to the circumstances known to the person, it is unjustifiable to take that risk.[45] This means that a person who enters into a relevant agreement or transaction will be ‘reckless’ if they are aware that:

  • there is a substantial risk that entering into the agreement or transaction will avoid or prevent the recovery of, or significantly reduce the recoverable amount of, employee entitlements and
  • doing so is unjustifiable in the circumstances.[46]

Company officer specific offences

Proposed subsections 596AB(1B) and (1C) specifically deal with the conduct of company officers. The effect of these provisions would be to ensure that officers of the company (the persons responsible for the relevant agreement or transaction taking place, but unlikely to be parties to the agreement or transaction themselves) are explicitly covered by the proposed offence provisions, including in circumstances where they are reckless as to the effect of the agreement or transaction.

Extending offences to related entities in a corporate group

Commonly corporate groups are managed by the same controlling minds (that is, directors or company officers). Proposed subsection 596AB(2) is intended to ensure that the criminal offence provisions in proposed subsections 596AB(1) and (1A) (discussed above) apply to:

  • a company that owes employee entitlements, but
  • was not party to a transaction.[47]

Proposed subsection 596AB(2) also ensures the offences in proposed subsections 596AB(1) and (1A) operate effectively to capture different sharp corporate practices, for example, where other entities in a corporate group enter into agreements that impact the employee entitlements of another company in the group. It does this by providing that the offence provisions in proposed subsections 596AB(1) and (1A) apply even if the company is not a party to the relevant agreement or transaction. By doing this, the risk that corporate groups and related entities of the company could be successfully used to frustrate the operation of the criminal offence provisions, and cause unpaid and outstanding employee entitlements to be funded by the FEG is reduced.

Extension to certain other transactions

Proposed subsection 596AB(2A) provides that all the offence provisions discussed above will apply even where:

  • the relevant agreement or transaction has been approved by a court[48] or
  • despite the agreement or transaction, the employee entitlements are not ultimately avoided, prevented, or significantly reduced, or are able to be recovered.[49]

The Explanatory Memorandum notes that these provisions are:

... included to ensure that there is a strong deterrent in the law for those that attempt to avoid the payment of a company’s employee entitlements or significantly reduce those entitlements that can be recovered, even if the attempt does not happen or is not ultimately successful.[50]

Exclusion of certain agreements or transactions

A deed of company arrangement (DOCA) is one of the possible alternative outcomes for a company put into voluntary administration other than liquidation.[51] A DOCA is an agreement between the company and its creditors that follows from a voluntary administration and is one potential mechanism of restructuring a company and returning it to solvency.[52]

During the operation of a DOCA, the company continues to trade and, importantly for the directors, the company is not insolvent while under a DOCA.[53] Importantly, a DOCA can include an agreement to waive or delay payment of debts, allow payments of debts in instalments, or compromises under which creditors agree to accept payment of a lesser amount in final settlement of their debts.[54]

Schemes of arrangement are another form of external administration that provide an alternative to companies seeking to restructure and avoid liquidation, by enabling the rights and liabilities of shareholders and creditors of a company to be reorganised and allowing the company to continue to trade.[55] The goal of a scheme of arrangement is to obtain a binding agreement that modifies, reorganises or alters the legal rights of shareholders and creditors.[56]

The Act does not restrict the nature of a scheme but typical features of schemes include a partial curtailment of the creditors’ rights such as accepting less than the full amount owed, allowing for interest free periods, payment by instalment over an extended period of time, or debt for equity swaps.[57]

Proposed defence in relation to certain agreements or transactions

Proposed subsection 596AB(2B) outlines that the offence provisions do not apply to relevant agreements or transactions if they were entered into:

  • because a scheme of arrangement was approved by a court under section 411 of the Act for the company that has outstanding employee entitlements or
  • as a result of a DOCA executed by the company which has the outstanding employee entitlements.

The Explanatory Memorandum notes that the purpose of excluding schemes of arrangement and DOCAs from the operation of the offence provisions is to:

... avoid undermining these mechanisms as legitimate options to rescue, reorganise or restructure a financially distressed business. Without these defences, compromises and DOCAs that include agreements or transactions which result in, or may have the effect of, avoiding the recovery of employee entitlements, could be at risk of contravening the criminal offence provisions.[58]

However, the above defences are not intended to apply to a DOCA or scheme of arrangement executed by another company that avoids or prevents the payment of, or significantly reduces the amount of, the employee entitlements that can be recovered of the company that has the outstanding entitlements.

Evidential burden in relation to certain agreements or transactions

The proposed note to proposed subsection 596AB(2B) provides that the defendant bears the evidential burden in relation to relying on the proposed defence. The Explanatory Memorandum notes:

This is appropriate because it would be peculiarly within the knowledge of the defendants (such as officers of the company or other persons employed by the company), as to whether a relevant agreement and transaction was:

  • entered into because a compromise or arrangement was approved by a Court under section 411 for the company that has the outstanding employee entitlements; or
  • entered into for the purposes of effecting a DOCA which had been executed earlier by the company which has the outstanding employee entitlements.[59]

In addition to the above, proposed subsection 596AB(2C) excludes liquidators and provisional liquidators from certain offences. This is because in carrying out their statutory duties, liquidators and provisional liquidators may cause the company to enter into agreements and transactions, for example, in realising the assets of and winding up the company.

As such, the recklessness offences will not apply to liquidators and provisional liquidators. However, the intentional offences continue to apply. This means that where a liquidator or provisional liquidator intentionally entered into agreements or transactions to avoid or prevent the recovery of entitlements of employees, or significantly reduce the employee entitlements which could be recovered, they will commit an offence.[60]

The proposed note to proposed subsection 596AB(2C) provides that the defendant bears the evidential burden in relation to relying on the proposed defence. The Explanatory Memorandum notes that his burden is imposed on the liquidator or provisional liquidator because:

... it would be peculiarly in a liquidator or provisional liquidator’s knowledge as to why and when a relevant agreement or transaction was entered into in the course of the company’s winding up. It would also be significantly more difficult and costly for the prosecution to disprove the fact that the relevant agreement or transaction was not entered into in the course of winding up the company.[61]

Penalties for breaching the criminal offence provisions

Item 18 amends table item 145 of Schedule 3 of the Act to specify that proposed subsections 596AB(1) to (1C) are criminal offence provisions with the following maximum penalties:

Offence Penalty
Proposed subsection 596AB(1): a person intentionally enters into an agreement or transaction with the intention of avoiding, preventing or significantly reducing the amount of employee entitlements that can be recovered.

For an individual, the maximum penalty is either or both of the following:

  • imprisonment for ten years or
  • a fine the greater of the following:

    a. 4,500 penalty units (currently $945,000[62]) or

    b. if the Court can determine the total value of the benefits that have been obtained by one or more persons and are reasonably attributable to the commission of the offence—three times that total value.

In the case of a body corporate, the maximum penalty is a fine of the greatest of the following:

  • 45,000 penalty units ($9.45 million[63])
  • if the Court can determine the total value of the benefits that have been obtained by one or more persons and are reasonably attributable to the commission of the offence—three times that total value or
  • 10% of the body corporate’s annual turnover (as defined in section 761A) during the 12-month period ending at the end of the month in which the body corporate committed, or began committing, the offence.
Proposed subsection 596AB(1A): a person intentionally enters into an agreement or transaction and is reckless as to whether it will avoid, prevent or significantly reduce the amount of employee entitlements that can be recovered.
Proposed subsection 596AB(1B): a company officer intentionally enters into an agreement or transaction with the intention of avoiding, preventing or significantly reducing the amount of employee entitlements that can be recovered.
Proposed subsection 596AB(1C): a company officer intentionally enters into an agreement or transaction and is reckless as to whether it will avoid, prevent or significantly reduce the amount of employee entitlements that can be recovered.

Source: item 18.

As noted above, due to the operation of the Criminal Code Act 1995, accessories to such offences are captured.[64] This means:

... any person who is an accessory to the commission of any of the offences through aiding, abetting, counselling or procuring the commission of that offence, will be taken to have committed that offence.[65]

Extending civil liability for avoidance of employee entitlements

Currently section 596AC of the Act provides that a person is liable to pay compensation where they contravene section 596AB (the criminal offence provision) in relation to the entitlements of employees of a company, the company is being wound up and the employees suffer loss or damage because of that contravention or actions associated with it. Whilst the provision goes on to state that the person is liable ‘whether or not’ they are ‘convicted of an offence in relation to the contravention’ of the criminal offence provision, as noted in the Explanatory Memorandum the result of current drafting is that the existing civil liability provisions operate in conjunction with the criminal offence provisions.[66]

Proposed civil liability regime

Item 11 will repeal existing section 596AC and replace it with proposed section 596AC, under which a civil contravention will arise when a person or company officer:

  • enters into a relevant agreement or transaction or
  • causes the company to enter into a relevant agreement or transaction and
  • the person knows, or a reasonable person in the position of the person would know, that the relevant agreement or transaction is likely to:
    • avoid or prevent the recovery of the entitlements of the employees or
    • significantly reduce the amount of the entitlements of employees that can be recovered.[67]

From the above it can be seen that ‘reasonable person’ test is a key element of the proposed civil penalty provisions. This is discussed below.

Should conduct extend to that which ‘hinders’ recovery of entitlements?

In relation to the ‘avoid or prevent’ aspect of the civil penalty provisions, during the Treasury exposure draft consultation process the Insolvency and Reconstruction Committee of the Business Law Section of the Law Council of Australia (LCA) recommended including ‘or hindering’ after ‘preventing’ as a way of extending the operation of the provisions to a wider range of persons involved in relevant transactions or agreements.[68]

‘Reasonable person’ test

The Explanatory Memorandum notes that it is intended that the term ‘reasonable person’ used in the civil penalty provisions contained in proposed section 596AC will apply ‘its common law definition’.[69] The Explanatory Memorandum notes that this means that an objective test is used to determine if there has been a contravention of the civil penalty provisions.[70]

The ‘reasonable person’ test is an objective one,[71] even if it incorporates consideration of various subjective factors.[72] Case law decided under other parts of the Act suggests that applying the objective ‘reasonable person’ test to determine whether a person knew, or ought to have known that the agreements or transactions were likely to avoid or prevent the recovery of the entitlements of the employees or significantly reduce the amount of the entitlements of the company that could be recovered the court will assess a wide range of factors including the facts and circumstances as they unfolded at the time without the benefit of hindsight, in the commercial context of the transaction or agreement as a whole.[73]

Further, the court will consider those factors and assess them objectively against a person of ‘ordinary competence or reasonable ability’ in the position of the person accused of breaching the civil penalty provisions.[74]

Issue: lack of a due diligence defence

During the Treasury exposure draft consultation process the Australian Institute of Company Directors (AICD) expressed concern that the provisions ‘could result in unjust outcomes for directors who are acting diligently and in good faith’.[75] The AICD noted:

It is an important general principle of corporate law that a director or other officer’s decisions should not be penalised for a decision where the decision was made in good faith, for a proper purpose, and in the best interests of the company. This is one of the key policy objectives of the business judgment rule in s 180 of the Corporations Act 2001 (Cth). That is, Australia’s corporate law must promote high standards of corporate governance, while simultaneously providing company directors with the flexibility to innovate and invest without fear of unwarranted legal liability.

In our view, the proposed civil penalty provision, as currently drafted, is inconsistent with this policy proposition. It could result in a significant civil penalty compensation order being imposed on a director or other officer for business decisions made in good faith and for a proper purpose, where they have acted on information available to them, and in a manner they rationally believed was in the best interests of the corporation. Unlike provisions such as Corporations Act 2001 (Cth) ss 180(1) (duty of care and diligence), 588FB (uncommercial transactions), or 588G (duty to prevent insolvent trading), the proposed s 596AC contains no defence or relief provision.[76] (emphasis added)

The AICD subsequently recommended the specific inclusion of a due diligence defence or alternatively, enabling the Court to consider the following factors before imposing liability:

(1)   The intended benefits (if any) of the relevant agreement or transaction on the company’s ability to meet its employee entitlement obligations;

(2)   The detriment of the relevant agreement or transaction to the company’s ability to meet its employee entitlement obligations;

(3)   Any legitimate purposes of the business in entering into the relevant agreement or transaction;

(4)   Any other relevant factors.[77]

The ‘significantly reduce’ threshold

For the civil penalty provisions to be breached, the relevant agreement or transaction must be likely to avoid or prevent the recovery of employee entitlements, or ‘significantly reduce’ the amount of the entitlements of employees that can be recovered.[78]

During the Treasury exposure draft consultation process, both the Australian Council of Trade Unions (ACTU) and the LCA expressed concern about the use of the word ‘significantly’ in the civil penalty provisions. For example, the ACTU argued:

... we are concerned that the threshold regarding “significantly” reducing the amount of employee entitlements is too high. Whilst we accept that the Commonwealth might wish to set a high bar in relation to an offence, we do not believe it is appropriate to duplicate that in the civil penalty and loss recovery provisions. Beyond deterrence, the focus of the civil liability and loss recovery provisions ought to be the employees. The current legislative framework for the enforcement of employee rights to payment under industrial instruments provides zero tolerance for non payments of amounts to any employee. The proposed amendments ought to reflect this. We accordingly suggest that “significantly” be removed from proposed section 586AC(1)(b)(ii).[79]

Similarly the LCA argued:

While a higher standard is an appropriate criterion for criminal contravention, removal of the word “significantly” in s 596AC(1)(b)(ii) would simplify the section and avoid unnecessary disputation.[80]

Extending offences to related entities in a corporate groups

Commonly corporate groups are managed by the same controlling minds (that is, directors or company officers). Proposed subsection 596AC(5) is intended to ensure that the civil penalty provisions discussed above apply to:

  • a company that owes employee entitlements, but
  • was not party to a transaction

in the same manner as proposed subsection 596AB(2) discussed above.[81]

Extension to certain other transactions

Proposed subsection 596AC(6) operates in the same manner as proposed subsection 596AB(2A) to ensure that the civil penalty provisions will apply even where the relevant agreement or transaction has been approved by a court. As such, the court’s approval will not create immunity from contravention of the civil penalty provisions.[82]

Accessorial liability

The effect of proposed subsections 596AC(2) and (4) is that a person or company officer who ‘is involved’ in a contravention of the civil liability provisions is taken to have contravened those provisions. The Explanatory Memorandum notes that this allows ‘such accessories to be captured by the various sanctions and personal liability consequences in the Part’ and provides the following example:

Vivek is an unregistered adviser who provides restructuring advice to businesses which are in trouble. Vivek advises Sandya, the owner of Zobee Pty Ltd, about transactions she can use which would avoid her needing to pay any of the entitlements of her employees. Vivek outlines a plan to Sandya which includes transferring the assets to another business at below market value and making all the employees redundant. Sandya carries out the plan and all the employees’ entitlements are avoided. Sandya has contravened subsection 596AC(1). In this case, Vivek is involved in Sandya’s contravention and has therefore contravened subsection 596AC(2).[83]

Exclusion of certain agreements or transactions

Proposed subsection 596AC(7) operates in the same manner as proposed subsection 596AB(2B) to ensure that the civil penalty provisions do not apply to relevant agreements or transactions if they were entered into because of a scheme of arrangement or DOCA.[84]

However, the above defences are not intended to apply to a DOCA or scheme of arrangement executed by another company for the purpose of avoiding, preventing or significantly reducing the amount of employee entitlements that can be recovered off the company that has the outstanding entitlements. In addition to the above, proposed paragraph 596AC(7)(b) excludes liquidators and provisional liquidators from the civil penalty provisions for the same reasons noted in relation to proposed subsection 596AB(2C).

Proposed subsection 596AC(8) provides that the defendant bears an evidential burden in relation to relying on the proposed defences discussed above.

Limitation on commencement of proceedings

Proposed subsection 596AC(9) provides that proceedings for a declaration of a civil penalty may only be commenced after a liquidator has been appointed to the company. The Explanatory Memorandum notes that the aim of this limitation is to:

... ensure that actions for contravention of the civil penalty provisions and for compensation for loss or damage (which is linked to contravention of the civil penalty provision) are only commenced once the impact on employee entitlements becomes evident as part of the liquidation process and not while a company is still actively trading or restructuring its affairs.[85]

Penalties for breaching civil liability provisions

Item 17 amends the table in subsection 1317E(1) of the Act to list proposed subsections 596AC(1), (2) and (3) as civil penalty provisions. This means that where those provisions are breached that person can be required to pay a pecuniary penalty of up to $200,000.[86]

The Explanatory Memorandum notes that ‘the introduction of the civil penalty provision will strengthen enforcement options available for contraventions of the Part’.[87]

Stand-alone civil compensation regime

The Bill seeks to ensure that the civil compensation provisions no longer operate in conjunction with – and therefore in reliance on – the criminal offence provisions.[88] As noted in the Explanatory Memorandum:

The new civil compensation provision no longer interacts with the Part’s criminal offence provision, and reduces confusion about how the provision is intended to operate.[89]

Liability to pay compensation

Proposed section 596ACA deals with the liability of persons who contravene proposed section 596AC. Proposed subsection 596ACA(1) provides that a person is liable to pay compensation if:

  • they breached the civil penalty provisions in proposed subsections 596AC(1), (2), (3) or (4) and
  • the employees of the company suffered loss or damage because of:
    • the relevant agreement or transaction or
    • action taken to give effect to the relevant agreement or transaction and
  • a liquidator has been appointed to the company.

A person may be liable to pay compensation regardless of whether:

    • a court has made a declaration of a contravention or a pecuniary penalty order under Part 9.4B of the Act (civil consequences of contravening civil penalty provisions) in relation to the person
    • the person was convicted of an offence based on section 596AB (as amended by the Bill) in relation to matters giving rise to the contravention or
    • the company has been wound up.[90]

Who can recover compensation?

Proposed subsection 596ACA(3) allows the company’s liquidator to recover (as a debt due to the company) from the person (which can include a company officer) an amount equal to the loss or damage. Proposed subsection 596ACA(4) confers a similar right on an employee (subject to proposed section 596AF, discussed below), recoverable as a debt due to the employee of an amount equal to the loss or damage suffered.

Limitations on civil compensation proceedings

The Bill imposes a number of limitations on civil compensation proceedings. First, proposed subsection 596ACA(6) provides that proceedings for compensation for breaches of proposed section 596AC may only be commenced within six years after the company begins to be wound up (that is, a liquidator is appointed).

Second, an employee can only commence proceedings in accordance with proposed section 596AF (discussed below). This means they will require the consent of the liquidator or leave of the court.[91]

Third, proposed section 596AG provides that proceedings cannot be commenced by an employee or other person with standing under proposed section 596AF (discussed below) if the company’s liquidator or another person with standing under proposed section 596AF has already commenced proceedings in relation to the contravention. The Explanatory Memorandum notes that in relation to the limitations imposed on employees this is because:

... the government bodies would already be taking action on behalf of that employee, and all the other employees, to recover their loss or damage.[92]

Standing of persons and bodies other than the company’s liquidator

Proposed section 596AF deals with civil compensation proceedings by persons other than the company’s liquidator. Proposed subsection 596AF(1) allows the following to begin civil compensation proceedings for breaches of the civil penalty provisions:

  • the Commissioner of Taxation (Commissioner)
  • the Fair Work Ombudsman (FWO)
  • the Secretary of the Department administering the FEG Act (Secretary) and
  • employees of the company (section 596AA of the Act provides this includes former employees).

Proposed subsection 596AF(2) provides that where a liquidator has been appointed to the company, civil compensation proceedings can only be commenced with the written consent of the liquidator, or with leave of the court. Proposed subsection 596AF(3) in turn provides that the court may only grant leave to commence civil compensation proceedings after certain procedural requirements are met and the court is satisfied that it is appropriate to grant leave, having regard to the following matters:

  • whether it is likely that the liquidator will begin civil compensation proceedings under proposed section 596ACA
  • whether the liquidator has applied under section 588FF for a court order that a transaction was a voidable transaction, and this same transaction also contravened proposed section 596AC or was part of a contravention of that section
  • whether the liquidator has intervened in an application for a civil penalty order under section 588G in relation to insolvent trading
  • whether the liquidator has begun proceedings under section 588M for recovery of compensation for loss due to insolvent trading, where the relevant transaction also contravenes proposed section 596AC and
  • any other matters the court considers relevant.

As noted above, proposed section 596AG imposes limits on when civil compensation proceedings can be commenced by an employee, the Commissioner, FWO or Secretary. However proposed subsection 596AH allows:

  • those bodies and entities to apply to the court to be joined as a party to the liquidator’s civil compensation proceedings under proposed section 596ACA or
  • the Commissioner, FWO, Secretary or an employee of the company to which the proceedings relate, and the company’s liquidator, to apply to the court to be joined to proceedings begun by the Commissioner, FWO or Secretary

as they have an interest in such proceedings.[93]

Issue: should trade unions have standing to commence proceedings on behalf of employees?

During the Treasury exposure draft consultation process ACTU argued that trade unions should also have standing to commence civil compensation proceedings on the basis:

... unions ought be identified as within the range of potential litigants. In all other underpayment matters, the Fair Work Ombudsman, the employee and their union are given equal status to pursue employees’ rights. We see no basis for a different approach here... Circumstances may arise where the Fair Work Ombudsman or other Commonwealth agencies are unwilling to pursue a matter, perhaps for instance if the funds at issue are comparatively small relative to amounts that those agencies are accustomed to dealing with. Unions may be in a better position to recover amounts for their members which, individually or collectively, are regarded as not significant enough to warrant the action of an interagency taskforce. Affected employees should have the option of asking their union to seek to recover their losses on a representative basis.[94]

Penalties in addition to compensation orders

As set out above, proposed section 596AC contains the civil liability provisions that underpin the civil compensation provisions. These provisions have maximum pecuniary penalties of up to $200,000.[95]

A person who breaches those provisions– in addition to being required to pay the relevant pecuniary penalties – could also be required to pay compensation for the loss or damage caused by those breaches.

Key issues and provisions: recovering entitlements from related entities

Part 2 of the Bill seeks to insert new provisions into the Act that allow contributions to be sought from certain entities in a corporate group, or entities with a closely connected economic relationship, for the payment of outstanding employee entitlements of an insolvent company, in limited circumstances. It does this by inserting proposed Division 8 into Part 5.7B of the Act.

In summary, proposed Division 8 of Part 5.7B of the Act would allow a court to make an employee entitlements contribution order (EECO), in essence an order requiring an entity in the same contribution order group as an insolvent company to contribute to the payment of the employee entitlement liabilities of the insolvent company where:

  • the entity has benefited from the labour of the employees of the insolvent company on other than arm’s-length terms and
  • it is 'just and equitable' to make the order.

During the Treasury exposure draft consultation process the AICD argued that in light of the other proposed reforms the proposed EECO regime was unnecessary as:

... the proposed civil penalty provision and new recklessness-based offence will, if legislated, represent a considerable enhancement to existing provisions and reduce inappropriate reliance on FEG. These measures should, if vigorously enforced, curb abuses of the FEG scheme. For this reason, the AICD does not believe there is sufficient justification for the imposition of a contribution order regime on corporate groups to share liability to meet unpaid employee entitlements.[96]

The HIA argued that ‘the proposed ‘employee entitlement contribution orders’ will operate ineffectually due to the omission of the need for a positive intent to avoid employee obligations in order to issue such orders’.[97]

When can an employee entitlements contribution order be made?

An EECO can only be made when the court is satisfied that all the elements in proposed subsection 588ZA(1) are satisfied, as discussed below.

Does the company being wound up have unpaid employee entitlements?

First, the court must be satisfied that a company is being wound up (liquidated). This is referred to as the insolvent company.[98] Second, the court must be satisfied that the insolvent company has unpaid employee entitlements of the type covered by Part 5.8A of the Act (as amended by the Bill).

Is the contributing entity a member of the same contribution order group?

Third, the court must be satisfied that the contributing entity (that is, the entity against which the orders are sought) is a member of the same contribution order group as the insolvent company. Proposed subsection 588ZA(6) contains six tests that can be used to determine if the insolvent company and contributing entity have the types of connected economic, control or ownership relationships covered by the Bill. Those test are where:

  • one of the entities is, or has been, a related body corporate of the other entity
  • one of the entities is, or has been, a related body corporate of a body corporate that is, or has been, a related body corporate of the other entity
  • one of the entities is, or has been, controlled by the other entity or a related body corporate of the other entity
  • both of the entities represent, or have represented, to the public that they are related to one another
  • both entities are, or have been, part of the same consolidated entity or
  • both entities are, or have been, part of a collection of entities that, as a matter of economic and commercial substance, functions or functioned as a single entity.

Importantly, only one of the six tests needs to be satisfied to determine that two entities are members of the same contribution order group, and hence – subject to the other elements being satisfied – subject to an EECO under proposed section 588ZA.

Related bodies corporate

The first two tests are concerned with related bodies corporate as defined in section 50 of the Act, that is where:

  • one body corporate is the holding company of the other body corporate
  • one body corporate is a subsidiary of the other body corporate or
  • one body corporate and the other body corporate are both subsidiaries of the same holding company.

As such – and because of the inclusion of the wording ‘or has been’ – proposed paragraphs 588ZA(1)(a) and (b) will capture entities that are (or were) related bodies corporate.[99]

Controlled entities

The third test captures entities where the court considers an entity has (or previously had) the capacity to control (as per section 50AA of the Act) the other entity’s financial and operating policies.[100]

Entities that publically represent they are related to one another

The fourth test captures entities where the court considers they have represented to the public that they are related to one another (whether or not they are).[101]

The Explanatory Memorandum notes that the fourth test aims to:

... capture circumstances where two entities represent in their business dealings that they are related to one another (even though they may not be). In these circumstances, employees may be led to believe or form the impression they are working for entities that are related to each other and may provide services on that basis.[102]

In determining whether the entities represented to the public they are related to one another, the Explanatory Memorandum suggests that the court can consider:

  • promotional material and other business documents published by the relevant entities
  • information in documents lodged with ASIC or other Government entities
  • communications between the entities and employees and other stakeholders of the entities and
  • annual reports of the relevant entities.[103]

As such, it appears that this test could – for example – be used to capture entities that are not related body corporates and do not share directors, but operate as a joint venture and represent to the public that they are related to each other, even though they are not.

Entities part of the same consolidated group

The fifth test captures entities in consolidated groups for accounting and financial reporting purposes as per section 9 of the Act. That is, a company, registered managed investment scheme or disclosing entity together with all the entities it is required by accounting standards to include in consolidated financial statements.[104] In turn, those accounting standards require the company, registered managed investment scheme or disclosing entity (as relevant) to prepare financial statements in which its investments in its subsidiaries are included (a consolidated financial statement).[105] In this respect it has been noted that the Act and accounting standards:

... do not treat each entity in a group as separate but recognise the reality that the entities in a group function as one economic entity.[106]

The Explanatory Memorandum notes that for the purposes of the fifth test, the court could consider materials such as:

  • current and previous years’ consolidated accounts prepared according to accounting standards
  • financial reports and other documents lodged with ASIC related to the relevant entities and
  • materials provided to financial institutions for purposes of financing for the consolidated entity.[107]

Importantly, the inclusion of the wording ‘or has been’ in proposed paragraph 588ZA(6)(e) will capture entities that are (or were) part of the same consolidated entity for accounting purposes.[108]

Entities that economically and commercially function as a single entity

The sixth and final test captures situations where both entities are (or have been) part of a collection of entities that as a matter of economic and commercial substance function or functioned as a single entity.[109]

The Explanatory Memorandum notes that when determining the sixth test above the court will consider the legal, commercial and operating structures of the entities, as well as the day-to-day operation of the businesses, to make a determination as to whether entities operated in this way. As such, for this test to be satisfied the entities will need to have operated closely together to achieve a set of common aims. The more integrated their operation, the more likely they will be operating as a single entity, as the following example demonstrates:

Chardonnay Pty Ltd is a trading entity which employs all the employees that work across the Mountain Group of companies. The assets of the group, being a winery, vineyards and its land, are held by Shiraz Pty Ltd. Chardonnay Pty Ltd and Shiraz Pty Ltd have different boards of directors and different shareholders.

On a day to day basis, the employees of Chardonnay Pty Ltd worked on the vineyards and in the winery of Shiraz Pty Ltd, to generate revenue for the Mountain Group. Chardonnay Pty Ltd is wound up and the company’s liquidator makes an application for an employee entitlements contribution order.

When considering whether the two entities were members of the same contribution order group, the Court could conclude that Chardonnay Pty Ltd and Shiraz Pty Ltd operated as a single entity by virtue of paragraph 588ZA(6)(f).[110]

Did the contributing entity benefit from the work done by the employees?

Provided the insolvent company and contributing entity are found to be members of the same contributing group under one or more of the tests above, the fourth element in proposed subsection 588ZA(1) is that the contributing entity has benefited (directly or indirectly) from work done by the employees of the insolvent company.[111] Whilst not set out in the Bill, it appears that this element requires the court to:

  • examine the entities making up the same contribution order group and
  • determine whether they received any benefits, by considering which entities in the contribution group the employees of the insolvent company did work for, and which entities made payments for that labour.[112]

Did the benefit exceed an appropriate amount?

The fifth element (proposed paragraph 588ZA(1)(e)) to be satisfied before an EECO can be made is that the benefit that the contributing entity has received exceeds the benefit that would be reasonable in the circumstances if the insolvent company and the contributing entity were dealing at arm’s length.

The Explanatory Memorandum notes that the court would determine the difference between:

  • a market rate for the services provided by the employees and
  • the actual amount paid or value of the consideration provided for those services.[113]

In doing so, a court could consider factors such as:

  • the price other entities in the contributing group, or a similar industry, pay for the work done by the employees
  • what the labour cost incurred by the insolvent company for the employees that provided those services would have been if all obligations related to the employees were met or
  • any other dealings or offset type arrangements between the entities.[114]

The Explanatory Memorandum provides the following example to illuminate the determination process discussed above:

Cabernet Pty Ltd is being wound up and the liquidator of the company, Jeremy, has applied to the Court for an employee entitlements contribution order. Merlot Pty Ltd, Semillon Pty Ltd and Cabernet Pty Ltd are members of the same contribution order group.

The employees of Cabernet Pty Ltd undertook work for both Merlot Pty Ltd and Semillon Pty Ltd. Cabernet Pty Ltd charged both Merlot Pty Ltd and Semillon Pty Ltd $100,000 for that work. The actual market value of the work done by the employees is $200,000 for each of those entities.

Both Merlot Pty Ltd and Semillon Pty Ltd have benefited from the work done by those employees, and that benefit exceeds the arm’s length value of the labour.[115]

Is it just and equitable to make the order?

The sixth and final element (proposed paragraph 588ZA(1)(f)) to be satisfied before an EECO can be made is that it is just and equitable to make the order. Proposed subsection 588ZA(4) sets out a non-exhaustive list of factors that the court can consider:

  • the size of the excess benefit determined under the fifth element (proposed paragraph 588ZA(1)(e))
  • the nature of the relationship between the contributing entity and the insolvent company
  • any efforts made by the contributing entity, or officers of the contributing entity, and officers of the insolvent company to pay or to provide for the payment of the unpaid entitlements amount
  • if the contributing entity is solvent—whether the order is likely to result in the contributing entity becoming insolvent
  • the extent (if any) to which the order is likely to result in the contributing entity becoming unable to pay the entitlements of its employees or make distributions to creditors and
  • any other matters that the court considers appropriate.

Effect of the order

Where the above elements are satisfied, under proposed subsection 588ZA(2) the court can issue an EECO requiring the contributing entity to pay to the liquidator of the insolvent company an amount that reflects the additional non-arm’s length benefit obtained by the contributing entity as determined under the fifth element (proposed paragraph 588ZA(1)(e)). As noted above, this excess benefit is calculated as the difference between:

  • the value of the benefit received (directly or indirectly) by the contributing entity from the work performed by employees of the insolvent company and
  • the value of the benefit that the court believes would be reasonable in the circumstances if the insolvent entity and the contributing entity operated as if they were dealing at arm’s-length terms.

Proposed paragraph 588ZA(2)(b) imposes a limitation on the maximum amount payable under an EECO: it cannot exceed the unpaid employee entitlements of the insolvent company protected by Part 5.8A of the Act.

Integrity measure

Proposed subsection 588ZA(3) prevents a contributing entity from claiming the payment of an EECO as an advance on account of wages or other employee entitlements. If this were not the case, the contributing entity could then seek to be repaid the amount as a priority creditor in the winding up of the company, defeating the policy purpose of the Bill.

Proposed paragraph 588ZA(5)(a) provides the court a discretion to order that an amount paid under an EECO is to be treated as a priority employee entitlement under section 556 of the Act owing to the liquidator if the contributing entity eventually enters into winding up. This would place the amount higher up in the order of debts and claims that must be paid in priority over all other unsecured debts and claims, thereby increasing the likelihood of the payment being made (either in full or in part). In addition, proposed paragraph 588ZA(5)(b) provides the court may make any orders and give any directions it believes necessary to give effect to an EECO, and to ensure it is paid to the insolvent company’s liquidator. This could, for example extend to how the payment is to be made, authorising or requiring a specific person to make the payment, time-limits for payment and so on.

Standing to seek an employee contribution order

Under proposed section 588ZB the following persons and bodies have standing to make an application for an EECO:

  • the liquidator of the insolvent company
  • the ATO
  • the FWO or
  • the Secretary.

Employees and former employees do not have standing

Importantly, unlike the civil compensation provisions an employee or former employee does not have standing to make an application for an EECO. No explanation for this difference is provided in the Explanatory Memorandum.

Liquidator can commence proceedings without consent of other parties

The effect of proposed subsections 588ZB(2) and 588ZA(1)(a) is that the liquidator of the insolvent company does not require permission from any party before making an application to the Court for an EECO.[116]

Limitations

To provide flexibility in the operation of the EECO provisions, proposed subsections 588ZB(2) and (3) provide that the ATO, the FWO or the Secretary may make an application for an EECO where:

  • the liquidator consents to the application
  • the court grants leave following a refusal by the liquidator (or a failure by the liquidator to make a decision within 30 days of the applicant seeking consent). The court may only grant leave if satisfied that it would be appropriate to do so, having regard to whether it is likely that the liquidator will commence proceedings seeking an EECO (for example, because the liquidator is not adequately funded) and any other matter the court considers relevant.

Proposed subsection 588ZB(4) provides that an application for an EECO must be made within six years after the beginning of the winding up of the insolvent company.

Key issues and provisions: disqualifying directors

Part 3 seeks to amend the Act and the Aboriginal Corporations Act to allow the disqualification of company directors and other officers with a track record of involvement in corporate contraventions and insolvencies, where the FEG scheme has been inappropriately relied on.

Current law relating to disqualifying directors of companies

The Act contains a number of provisions which provide for the disqualification of directors. This includes:

  • automatic disqualification
  • disqualification by court processes and
  • disqualification by the regulator (the Australian Securities and Investments Commission (ASIC)) in limited circumstances.[117]

None of the processes allow the Minister, shareholders or other stakeholders in the corporation (such as employees or former employees) to seek to have directors disqualified. Only ASIC has this power. The Appendix to this digest examines the grounds for disqualification most relevant to the Bill’s proposals, to give context to the proposed amendments.

Disqualifying directors for unrecovered employee entitlements

The Bill will amend Part 2D.6 of the Act to enable:

  • ASIC and
  • the Federal Court

to disqualify company directors and other officers who have a track record of involvement in contraventions of the Act and insolvencies where:

  • the FEG scheme has inappropriately funded the payment of outstanding employee entitlements and
  • there has been a minimal return to the Commonwealth.

Disqualification by the Court order

Proposed section 206EAB deals with disqualification of persons from managing corporations for the reasons outlined above by the Federal Court.

Who has standing?

Consistent with the existing disqualification regime contained in the Act, proposed subsection 206EAB(1) provides only ASIC with standing to apply to the Federal Court for a disqualification order.

When can the Court disqualify a person?

The Court can disqualify a person from managing corporations for a period of time it considers appropriate, where the Court is satisfied the disqualification is justified, and the elements below are satisfied in relation to the person in relation to two or more corporations.[118] This includes Aboriginal and Torres Strait Islander corporations.[119]

Was the person an officer of two or more corporations?

The first element is that the person was an officer of two or more corporations. The effect of proposed paragraph 206EAB(1)(a) is that a person can only be disqualified where the elements discussed below apply to two or more corporations. This is designed to ensure that disqualification applies in circumstances where the person has, or the corporations they are responsible for have, contravened corporations law on multiple occasions.[120]

Was the person an officer of the corporation?

The second element is that during the last seven years the person was an officer of the corporations in question.[121] The Act defines an ‘officer’ in such a way as to include a person:

  • validly appointed as a director (regardless of the name given to the position)
  • who makes, or participates in making, decisions that affect the whole, or a substantial part, of the business of the corporation or
  • who has the capacity to affect significantly the corporation’s financial standing or
  • in accordance with whose instructions or wishes the directors of the corporation are accustomed to act (excluding advice given by the person in the proper performance of functions attaching to the person’s professional capacity or their business relationship with the directors or the corporation) or
  • appointed as a receiver, a receiver and manager, an administrator, a liquidator and a trustee or other person administering a scheme of arrangement.[122]

By requiring that the person was an officer of the corporation in question the Bill captures a wide range of persons who have significant influence, control or capacity to affect the corporation’s decisions or operations.

Was winding up of the corporation commenced?

The third element is that:

  • while the person was an officer or
  • within 12 months after the person ceased to be an officer
  • the corporation began to be wound up.[123]

The Explanatory Memorandum notes that this is designed so that officers who ‘engage in sharp corporate practices that result in insolvency and inappropriate reliance on FEG’ but resign from the company ‘to avoid liability’ are nonetheless ‘appropriately captured by the provisions’.[124]

Was money advanced for the purpose of paying employee entitlements?

The fourth element is that money was advanced for the purposes of paying the entitlements of employees of the corporation under the FEG Act, that is, money was advanced to employees under the FEG.[125]

Issue: should non-payment of employee entitlements be a basis for liability?

The AICD expressed concerns about non-payment of employee entitlements being a basis for liability, rather than the circumstances surrounding the non-payment being an aggravating factor to be considered by the court, noting:

We are concerned that the threshold requirements proposed... will, in some circumstances, unfairly penalise entrepreneurial directors, or directors who are involved in multiple start-ups over a lengthy period. It is conceivable that directors could be involved with companies that fail with a need to rely on the FEG scheme through no deliberate abuse of the system or misconduct, but because of the risks associated with start-ups and innovative firms. It would be contrary to the [National Innovation and Science Agenda] NISA policy objectives to unfairly penalise directors embracing the risks of innovative firms.[126] (emphasis added).

Has the Commonwealth received minimal or no return on the advance?

The fifth element is that the Commonwealth has (at the time of the order is made) not received a return (or has only received a minimal return) on the advance.[127] A minimal advance is defined in proposed subsection 206EAB(3) as ten cents in the dollar or less of the amount advanced to employees by the Commonwealth under the FEG.

Is it unlikely that the Commonwealth will receive more than a minimal return on the advance?

The sixth element is that Court is satisfied that the Commonwealth is unlikely to receive more than a minimal return on the advance.[128] In this regard the Explanatory Memorandum notes that the Court could have regard to:

  • any reports provided by the liquidator to ASIC on the likely return to creditors in the winding up of the company
  • the potential impact of any litigation on foot in relation to the company and
  • other matters it considers relevant.[129]

This in turn allows the Court to form a view on the likely return to the Commonwealth, and enables disqualification action to proceed even when a liquidation has not yet been finalised. This is desirable as:

Many liquidations can take several years to complete, and having to wait for a liquidation to be finalised could frustrate the objectives of the disqualification power in section 206EAB.[130]

Did the person or the corporation contravene the Act or related legislation?

The seventh element is that either of the following occurred during the last seven years in relation to the two corporations that the person was an officer of:

  • the corporation contravened the Act or the Aboriginal Corporations Act while the person was an officer of the corporation and the person failed to take reasonable steps to prevent the contravention or
  • the person contravened the Act or the Aboriginal Corporations Act while the person was an officer of the corporation.[131]
  • The Explanatory Memorandum notes that no causal connection is required between the contraventions by the officer of the corporation or the contraventions by the corporation and either:
  • the resulting FEG advance made to former employees of the company or
  • the resulting or likely minimal return of the FEG advance through the company’s liquidation process.[132]

The Government notes that the reason for not requiring a causal connection ‘is to facilitate the protective purpose’ of proposed section 206EAB.[133] Further, the Explanatory Memorandum notes that whilst even minor contraventions by the company or the relevant person can satisfy this element, the Court will consider the nature and severity of the contraventions in determining whether the disqualification is justified.[134]

Is disqualification justified?

The eighth and final element is that disqualification is justified.[135] Under proposed subsection 206EAB(4) when determining whether disqualification is justified the Court may have regard to:

  • the person’s conduct in relation to the management, business or property of any corporation and
  • any other matters that the Court considers appropriate.

The Explanatory Memorandum provides examples of the types of matters the Court can take into consideration when determining whether disqualification is justified – other than the nature of the contraventions discussed above – including:

  • whether the person, or corporation the person was an officer of, complied with their obligations under the Act
  • information relating to the person’s fitness to continue managing corporations in the future
  • the nature or severity of the relevant corporate contraventions
  • the impact disqualification might have on the person, or on the corporations they may currently be an officer of and
  • whether disqualification will further the objectives of the Part and would be in the public interest.[136]

In this regard, proposed subsection 206EAB(4) is very general – much of the detail about how the provision is intended to operate is set out in the Explanatory Memorandum rather than in the proposed provision itself. Whilst the Explanatory Memorandum is a relevant extrinsic material that can be used by a Court when interpreting proposed subsection 206EAB(4),[137] nonetheless the Court may simply decide on an interpretation of proposed subsection 206EAB(4) without reference to the Explanatory Material.

That said, in relation to the fourth point above – the nature or severity of the corporate contraventions – as noted above whilst even minor contraventions by the company or the relevant person can satisfy the seventh element, it might be considered that these would only justify disqualification where such breaches related substantially to:

  • the failure of the company or
  • significant departures from accepted standards of corporate governance.

In this regard the Explanatory Memorandum provides the following examples of contraventions that are likely to satisfy the seventh element and potentially justify disqualification:

  • the failure of an officer to ensure the corporation kept books and records to the appropriate standard, or at all
  • the destruction or loss of the books and records of the corporation, whether by an officer or employees of the corporation
  • failing to assist or hindering the company’s liquidator in their investigations
  • failure by the person to comply with orders of ASIC, whether directed to them or the corporation or
  • any other corporate contravention, such as contraventions of director duties, not providing required information or providing misleading information to ASIC, or not meeting financial reporting requirements.[138]

However, unlike the proposed ASIC disqualification regime, the Federal Court is not required to consider whether the relevant corporations were related to each or whether the disqualification would be ‘in the public interest’ when determining whether to make a disqualification order.

Period of disqualification

Provided all the elements discussed above are satisfied, the Court can disqualify a person from being an officer of a corporation for any period of time it considers appropriate.[139]

Disqualification by ASIC

Proposed section 206GAA deals with disqualification of persons from managing corporations by ASIC. This includes Aboriginal and Torres Strait Islander corporations.[140]

When can ASIC disqualify a person?

ASIC can disqualify a person from managing corporations for up to five years, where the elements set out in proposed subsection 206GAA(2) (discussed below) apply and:

  • ASIC has given the person a notice requiring them to demonstrate why they should not be disqualified
  • ASIC has given the person an opportunity to be heard on the question and
  • ASIC is satisfied the disqualification is justified.[141]

Elements to be satisfied before a disqualification order can be made by ASIC

The proposed power of ASIC to disqualify directors in relation to unpaid employee entitlements largely replicates the elements of the Federal Court disqualification process discussed above, with some differences. The elements shared by both the proposed Federal Court and ASIC disqualification regimes are as follows:

  • within the last seven years, was the person an officer of two or more corporations?
  • was winding up of the corporations commenced?
  • was money advanced under the FEG for the purpose of paying employee entitlements?
  • has the Commonwealth received minimal or no return on the advance?
  • is it unlikely that the Commonwealth will receive more than a minimal return on the advance? and
  • did the person or the corporation contravene the Act or the Aboriginal Corporations Act?[142]

Readers are referred to the discussion above in relation to these elements. Importantly however, even where all the above elements are satisfied, under proposed paragraph 206GAA(1)(c) ASIC could still determine that disqualification isn’t justified.

What follows below is an examination of the additional elements applicable to the proposed ASIC disqualification regime, but not the proposed Federal Court disqualification regime.

Notice and hearing requirements

Proposed paragraph 206GAA(1)(b)(i) provides that ASIC must provide the person with a notice outlining that ASIC intends to disqualify them from managing corporations. In turn, proposed paragraph 206GAA(1)(b)(ii) provides that ASIC must provide the person with an opportunity to be heard on the question of whether they should be disqualified or not.

Is disqualification justified?

As with the proposed Federal Court disqualification regime, ASIC must be satisfied that disqualification of the person is justified.[143] Readers are referred to the previous discussion regarding matters considered by the Federal Court in making this determination, which are largely replicated in relation to ASIC.[144] Importantly however, unlike the proposed Federal Court regime, ASIC must – in addition to the requirements discussed above – have regard to whether the relevant corporations were related to each other.[145] ASIC may then also have regard to whether:

  • the person’s conduct in relation to the management, business or property of any corporation
  • the disqualification would be ‘in the public interest’ and
  • any other matters ASIC considers appropriate.[146]

No explanation as to why ASIC (but not the Federal Court) is explicitly able to consider whether the disqualification would be in the public interest is provided. However, in relation to whether the relevant corporations were related to each other the Explanatory Memorandum notes:

... ASIC must have regard to whether the two or more corporations in question are related within the meaning of section 50 of the Corporations Act. This means ASIC must have regard to the relationship between the corporations, which is particularly relevant to situations involving the failure of a corporate group involving multiple insolvent companies that have inappropriately relied on FEG.[147]

Period of disqualification

If all the elements discussed above are satisfied, ASIC can disqualify a person from being an officer of a corporation for a period of up to five years.[148]

Other provisions

ASIC can grant a disqualified person leave to manage a corporation

Proposed section 206GAB allows ASIC to grant leave to persons who have been disqualified by ASIC (but not the Federal Court) from managing corporations under section 206F or proposed section 206GAA of the Act to manage a particular corporation or corporations, subject to any conditions and exceptions it considers appropriate. The insertion of this provision makes current subsection 206F(5) redundant and it is removed by item 27.

Transitional and application provisions

Part 4 of the Bill contains transitional provisions related to the above.

The provisions in Part 1 of Schedule 1 to the Bill (criminal offences, civil penalties and civil compensation proceedings) will apply in relation to a relevant agreement or a transaction that is entered into on or after the commencement of the Bill.[149] Likewise the amendments related to contribution orders will apply in relation to the winding up of a company that begins at or after the commencement of the amendments.[150]

Retrospective operation of director disqualification regime

In relation to the disqualification of directors by the Federal Court or ASIC, the seven year period in which the disqualification regime applies is able to include a period up to five years before the day on which the new disqualification provision begins operation. That is, it can apply retrospectively to conduct that occurred before the commencement of the amendments.[151]

However, proposed subsection 1649(2) provides that a person can only be disqualified from managing corporations under the new regime if at least one of the corporate contraventions by the officer, or by the corporation while the person was an officer, occurred after the commencement of the relevant section.

This means that whilst the disqualification regime can apply to conduct that occurred before the commencement of the amendments, at least one instance of relevant conduct must occur after the amendments commence.

Both the LCA and AICD raised concerns about the retrospectivity of the proposed measures.[152]

Concluding comments

The Bill is a result of a range of consultation processes and appears to have wide in-principle support from most stakeholders. If enacted, the reforms may be more effective than the current regime and therefore reduce deliberate and inappropriate reliance on the FEG. However, the effectiveness of such a deterrent effect may – in part – turn on the effectiveness of enforcement of the laws by ASIC and related regulators with standing.

Appendix: director disqualification provisions under the Corporations Act 2001

As noted in the body of this digest, the Act contains a number of provisions which provide for the disqualification of directors. The grounds for disqualification most relevant to the amendments proposed by the Bill are briefly outlined below, to give context to the amendments proposed by the Bill.

Automatic disqualification

Currently section 206B of the Act automatically disqualifies a person from being a director of a corporation, if they are convicted of serious criminal offences or are an undischarged bankrupt.[153] Relevantly to the Bill, section 206B provides that a person is automatically disqualified from being a director of a company if they are convicted for a contravention of the Act punishable by imprisonment for a period of greater than 12 months.

As noted in the digest, proposed section 596AB imposes criminal liability on persons and company officers who intentionally or recklessly enter into transactions that prevent or avoid the recovery of, or significantly reduce the amount that can be recovered of, a company’s employee entitlements. The maximum period of punishment for those offences includes imprisonment for ten years.

As such, where a person is convicted of one of the offences in proposed section 596AB, existing section 206B of the Act will operate to automatically disqualify that person from being a director of a corporation.

Disqualification by court order

Part 2D.6 of the Act provides the Court with power to disqualify directors in a range of circumstances which, relevantly to the measures proposed by the Bill, includes:

  • where a director has contravened certain civil penalty provisions in the Act or the Aboriginal Corporations Act (section 206C)
  • where a director is involved in repeated corporate insolvencies and non-payment of debts (section 206D) and
  • where a director has repeatedly been involved in contraventions of the Act or the Aboriginal Corporations Act, and failed to take reasonable steps to prevent contraventions by the company (section 206E)

The grounds of disqualification most relevant to the amendments proposed by the Bill are briefly examined below.

Contraventions of civil penalty provisions contained within the Corporations Act

Section 206C gives the court the power to disqualify a director for any period it considers appropriate where the director breached various civil penalty provisions contained within the Act or the Aboriginal Corporations Act and the court is satisfied that the disqualification is justified. Such proceedings can only be commenced by ASIC – not by other stakeholders (such as shareholders, creditors or former employees) or the Minister.

As noted in the digest, proposed section 596AC contains a number of civil penalty provisions that apply to persons and company officers who enter into agreements or transactions, or cause a company to enter into an agreement or transaction, where they know (or a reasonable person in their position would know) that agreement or transaction would prevent or avoid the recovery of, or significantly reduce the amount that can be recovered of, a company’s employee entitlements.

As such, where a person is found to have breached one of the civil penalty provisions in proposed section 596AC, existing section 206C of the Act will operate to allow the court to disqualify that person from being a director of a corporation.

Repeated involvement in corporate insolvencies is insolvent and non-payment of debts

Section 206D gives the court the power to disqualify a director for up to 20 years if:

  • within the last seven years, the person was an officer of two or more failed companies and
  • the court is satisfied that the manner in which the corporation was managed was wholly or partly responsible for the corporation failing and
  • the disqualification is justified.

Importantly however, applications for a disqualification order under section 206D can only be made by ASIC, not by other stakeholders (such a creditors, shareholders or employees) or the Minister.

Clearly, existing section 206D can also apply to the circumstances potentially covered by proposed section 206EAB. This is because proposed section 206EAB applies to companies that not only have been liquidated, but also have commenced being wound up. As such both existing section 206D and proposed section 206EAB can apply to circumstances where a person was an officer of two or more failed companies within a seven year period, the management of the corporations was at least partly responsible for its failure and the disqualification is otherwise justified.

Repeated contraventions of the Corporations Act

Section 206E provides the court with power to disqualify a director for any period it considers appropriate where:

  • the person has at least twice been an officer of a company that contravened the Act or the Aboriginal Corporations Act and the person failed to take reasonable steps to prevent a contravention or
  • the person contravened the Act or the Aboriginal Corporations Act at least twice while they were an officer of the company
  • the person was an officer of a body corporate and did something that would have contravened subsection 180(1) or section 181 (which require directors and other officers of corporations to exercise their powers and discharge their duties with care, diligence, good faith and for a proper purpose) if the body corporate had been a corporation and
  • the court is satisfied that the disqualification is justified.

Again however, applications for disqualification under section 206E can only be made by ASIC, and not by the Minister, shareholders, creditors or other stakeholders such as employees.

As such, contraventions of proposed sections 596AB and 596AC by either the company, or the person, could both potentially trigger existing section 206E. For example, a person may commit an offence under proposed subsection 596AB(1B) whilst an officer of one company, then two years later be fined under proposed subsection 596AC(3) whilst an officer of another company. In such circumstances, provided the other elements above were satisfied, existing section 206E of the Act may also allow the court to disqualify the director.

Disqualification by ASIC

Section 206F gives ASIC the power to disqualify a director for up to five years. ASIC may give notice to a director under section 206F if:

  • within the last seven years they were an officer of two or more companies that were wound up (liquidated) whilst the person was an officer, or within 12 months after the person ceased to be an officer of those corporations and
  • the liquidators lodged reports under subsection 533(1) about the inability of the company to pay its debts[154]
  • ASIC provides the person an opportunity to demonstrate why they should not be disqualified as a director and an opportunity to be heard on the question and[155]
  • ASIC is satisfied that the disqualification is justified.[156]

Clearly, existing section 206F and proposed section 206GAA can overlap. This is because proposed section 206GAA applies to companies that not only have been liquidated, but also have commenced being wound up. As such both existing section 206F and proposed section 206GAA can apply to circumstances where a person was an officer of two or more failed companies within a seven year period, the management of the corporations was at least partly responsible for its failure and the disqualification is otherwise justified.