By Lauren Drummond

Who pays employee entitlements when a company goes broke? In some circumstances it could be you and me (taxpayers) via the Commonwealth-funded Fair Entitlements Guarantee (FEG) scheme. This scheme is available to pay certain employment entitlements when insolvent businesses are unable to pay them.

Average annual costs under the FEG scheme has more than tripled from $70.7 million in the four-year period between 1 July 2005 and 30 June 2009, to $243.6 million in the four-year period between 1 July 2013 and 30 June 2017.

The Federal Government is concerned that certain corporate employers and associated parties are increasingly adopting a range of questionable practices that seek to shift the cost of outstanding employee entitlements onto the FEG scheme.

Rising from the ashes …

These corporate practices include phoenix activity, which involves the transfer of assets from an existing company to a new company without paying fair or market value. The same business is continued under the new company, leaving any debts (such as taxes, creditors and employee entitlements) with the existing company, which is liquidated.

The Government has released for discussion proposed changes to the Corporations Act 2001 (Cth) (Corps Law), which are aimed at deterring employers from engaging in these practices.

Corps Law already protects employee entitlements from relevant agreements and transactions that are entered into with the intention of defeating the recovery of those entitlements.

Criminal offence

Corps Law does this by making it a criminal offence for persons to enter into a relevant agreement or transaction with the intention of preventing the payment of, or significantly reducing some or all of, a company’s employee entitlement liabilities.

In addition, a liquidator (or employees in select circumstances) can bring a civil action to recover the loss or damage incurred by the avoidance of the payment of the employee entitlements.

However, since its introduction into the law in 2000, there have been no successful criminal or civil court actions under these provisions.

Disqualification

The new laws would facilitate disqualification of company directors of two or more companies that have relied on the FEG scheme and have breached the Corps Law on at least two occasions. The same applies to a company officer.

The criminal offence provision would be extended to include a person who enters into an agreement or transaction that avoids the payment of, or significantly reduces the amount of, the employee entitlements liabilities of a company that can be recovered, where the person is ‘reckless’ as to those possible outcomes.

A new civil recovery provision would apply, where contravention is determined by an objective assessment of what a reasonable person would have known, or been expected to have known, in the specific circumstances of the case, about the relevant agreements or transactions claimed to have caused loss or damage to the company’s employees.

The Australian Taxation Office (ATO), the Department of Jobs and Small Business (DJSB) and the Fair Work Ombudsman (FWO) would be given standing to initiate civil recovery proceedings.

Common structure

Many businesses operate using a group structure of several companies with a parent company controlling the group. One or more subsidiary companies in the group may employ staff and incur employee entitlement liabilities. The other subsidiary or subsidiaries may hold the assets of the group.

If all members of the corporate group legally operate as a single economic unit and enter into a deed of cross guarantee for all the group’s liabilities, the insolvency of the corporate group members with employee entitlement liabilities are not likely to adversely impact payment of those entitlements.

This is because the legal guarantee would require all the solvent group members to meet the insolvent member’s debts.

Deed of cross guarantee

Where there is no deed of cross guarantee or similar arrangement, the insolvency of a corporate group member with employee entitlement liabilities can result in those entitlements not being paid.

As the insolvent entity often has no or limited assets to meet those entitlements, it won’t be able to pay the entitlements. This is likely to shift the cost of the corporate group’s outstanding employee entitlement obligations to the FEG scheme, even where the corporate group, as an economic entity, has capacity to pay the outstanding entitlements, but chooses not to as it is not legally obliged to.

Hence, the Federal Government is proposing to amend the Corps Law to allow contributions to be sought from entities across a corporate group for the payment of outstanding employee entitlements of insolvent group entities, in appropriate circumstances.

Liquidators (plus the ATO, FWO, and DJSB) would be able to seek ‘employee entitlements contribution orders’ that require entities within a group of entities (including a corporate group) to contribute in certain circumstances to the payment or recovery of employee entitlement debts of an insolvent group entity where:

• it is ‘just and equitable’; and
• the group entities have benefitted from the labour of the employees of the insolvent entity on other than arm’s-length terms.