Insolvency reform to address corporate avoidance of employee entitlements

The Commonwealth has released an exposure draft of the Corporations Amendment (Strengthening Protections for Employee Entitlements) Bill 2018 (Bill) for consultation which will make key amendments to the Corporations Act 2001 (Cth) (Corporations Act). The Bill strengthens the current provisions aimed to deter companies from diverting assets to avoid the payment of employee entitlements on insolvency. The proposed changes will impact:

  • company officers and professional advisors, in assessing and structuring arrangements, and
  • liquidators, in reviewing potential claims held by the company.

Once the new legislation is enacted, failure by professional advisors to reflect the new regime in their structuring advice may expose them to potential claims of negligence.

Background to the new Bill

Over the last two years, the Commonwealth has begun to address what it regards to be significant levels of attempted corporate avoidance of employee entitlements, and misuse of the Fair Entitlements Guarantee scheme (FEG Scheme). In May 2017, the Department of Jobs and Small Business (Department) released a Consultation Paper seeking comment on several ideas to address this practice. Many of those ideas have now been further developed and progressed into the Bill.

Part 5.8A of the Corporations Act currently provides a regime intended to address the intentional avoidance of employee entitlements. However, since the Part’s introduction in 2000, there have been no successful criminal or civil court actions under the provision of the Part. The Part has been criticised for its ineffectiveness.1

The Bill intends to strengthen the ability of liquidators and the Department to pursue officers and advisers who are involved in structuring arrangements which avoid employee entitlements. This aims to act as a deterrent of such future conduct, and in-turn reduce the drain on the taxpayer funded scheme.

This article summarises the proposed amendments under the Bill, namely:

  • strengthening the ability to make claims in insolvency regarding conduct which impacts upon the recovery of employee entitlements;
  • the ability to seek contribution from entities in a corporate group for the payment of outstanding employee entitlements of an insolvent member of that group; and
  • further scope for disqualification of directors or officers of two or more companies that have relied on the FEG Scheme and have also breached the Corporations Act on at least two occasions.

FEG Scheme

The FEG Scheme provides financial assistance for certain unpaid employee entitlements where employees are made redundant due to the liquidation or bankruptcy of their employer.

The Department considers that employers have increasingly been adopting a range of questionable practices, such as phoenix activity, which seek to prevent, avoid or reduce the payment of obligations to creditors.2

As a result, the average costs under the FEG Scheme have more than tripled from $70.7 million in the four-year period between 2005 and 2009, to $243.6 million in the four-year period between 1 July 2013 and 30 June 2017.3

The Bill aims to combat these practices.

Amendments – Employee Entitlements (Part 5.8A)

The Bill intends to amend Part 5.8A of the Corporations Act to strengthen the ability of liquidators and other parties to make claims regarding transactions which reduce the recoverability of employee entitlements in insolvency. Central to these amendments is the movement away from the current subjective test of intention to a broader approach.

The key proposed changes to the current law are as follows.

Current Law Proposed Law
  • It is a criminal offence under section 586AB for persons to enter into a relevant agreement or transaction that intentionally avoids the payment of, or significantly reduces the amount of, a company’s employee entitlement liabilities.
  • The current criminal offence under is retained but it has been redrafted.
  • It will expressly be a contravention (and an offence) if the person enters into a relevant agreement or transaction which is reasonably likely to prevent or significantly reduce the recoverability of employee entitlements.
  • This will apply even if the arrangement is court approved (except a DOCA) or there is no loss (ie. the entitlements are ultimately recovered).
  • The penalty for an individual is imprisonment for 10yrs or a fine of the greater of 4,500 penalty units (current total, $725,355) or 3 times the total value of the benefits reasonably attributable to the offence.
  • The penalty for a body corporate is a fine of the greater of 45,000 penalty units (current total, $7.25m), 3 times the total value of the benefits reasonably attributable to the offence, or if the court cannot determine the total value, 10% of the body corporate’s annual turnover during the 12 months before they committed the offence.
  • Under the civil recovery provision in section 596AC, a liquidator can bring civil recovery action to recover the loss or damage incurred by avoidance, or a significant reduction of the amount, of the company’s ability to meet employee entitlement liabilities.
  • Breach of the civil recovery provisions occurs where the criminal offence provision is contravened (including subjective intent), but proven on the balance of probabilities.
  • The civil recovery provision no longer relies on the criminal offence provision as its foundation.
  • An objective test is added to the current subjective test of intent.
  • It will be a contravention if the person enters a relevant agreement or transaction which they knew, or a reasonable person in their circumstances would likely have known, is likely to prevent or reduce the recoverability of employee entitlements.
  • While the contravention will occur even if the arrangement is court approved (except a DOCA) or there is no loss (ie. the entitlements are ultimately recovered), for compensation to be payable, employees must have suffered loss or damage because of the agreement (or actions taken to give effect to it). By operation of section 560 of the Corporations Act, this will include FEG as subrogated to the employee’s rights.
  • Civil recovery action can be brought by the company’s former employees where they have the consent of the company’s liquidator or the court.
In addition to employees, parties who can initiate civil recovery action (with the liquidator’s consent or Court leave) is expanded to include the Commissioner of Taxation (ATO), Fair Work Ombudsman (FWO) and Department.

 

Amendments – Contribution Orders

The Bill also inserts new provisions into Part 5.7B of the Corporations Act. These allow contribution to be sought from entities in a corporate group for the payment of outstanding employee entitlements of an insolvent member of that group.

In summary, liquidators (and the ATO, FWO and Department) will be able to seek ‘employee entitlements contribution orders’ from the Court that require entities within a group of entities to contribute in certain circumstances to the payment or recovery of employee entitlement debts of an insolvent group entity. This will apply 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 arms-length terms.

Notably, this will include any entities which are represented to the public as being related (whether or not they actually constitute related entities under the Corporations Act).

This is an important new tool available to liquidators as well as the ATO, FWO and Department.

Amendments – Disqualification from managing corporations

The third component of the Bill amends Part 2D.6 of the Corporations Act to introduce new provisions to disqualify company directors and company officers with a history of involvement in insolvencies in which FEG is required to fund unpaid employee entitlements.

ASIC and the Courts may disqualify persons from managing corporations where companies to which they have been appointed have been liquidated, and the former employees of those companies relied on FEG to pay their outstanding employee entitlements.

This may occur where, within 10 years, there were two or more separate occasions where:

  • there was a breach by the company or the director or the officer of the Corporations Act; and
  • FEG did not receive any return or only a minimal return (10 cents in the dollar or less), through the liquidation process or other recovery processes.

ASIC will be able to disqualify company directors and officers under the new provisions for a period of up to 10 years from the date a notice of disqualification is served. The Court will be able to disqualify directors and officers for a period the Court thinks is appropriate.

Conclusion

The proposed amendments under the Bill have the potential to have an important impact on both the conduct of directors and officers of companies and the avenues open to liquidators, employees, the Department, ATO and other entities to take action in respect of the avoidance of employee entitlements.

Officers and directors of companies and liquidators should inform themselves of the potential changes and ensure that legal advice is sought where appropriate.

This article was written with the assistance of James Fisher, Law Graduate.


1For example, see Reforms to address corporate misuse of the Fair Entitlements Guarantee scheme, Consultation paper, May 2017, Australian Government, Part 5.
2Department of Jobs and Small Business, Reforms to address corporate misuse of the Fair Entitlements Guarantee scheme, Consultation Paper (2017), 4.
3Explanatory Memorandum, Corporations Amendment (Strengthening Protections for Employee Entitlements) Bill 2018, 6.


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