08 July 2005
Secured creditors may have to take a back seat to employees of insolvent companies.
Last week, the House of Lords effectively ruled that, as it operated in practice, a common form of security used by English lenders gave no protection from priority claims for employee entitlements in insolvency.
For Australian lenders, the good news is that House of Lords decisions don't bind Australiancourts.
The bad news is that the security documents used in England are quite similar to those used in Australia.
The neither-good-nor-bad news is that no-one knows if Australiancourts will follow the House of Lords decision.
This is, of course, extremely relevant to insolvency practitioners. Liquidators in particular will be aware of the important role played by the Commonwealth's GEERS scheme inpaying and recovering employee entitlements. It is, therefore, extremely likely that Australiancourts will at some stage be asked to rule on this issue.
Background
By taking a charge over company assets, lenders can usually ensure that they get paid out before other creditors if the company goes into liquidation.
However, if the security is in the form of a floating charge, the Corporations Actgives employee entitlements (up to a specified amount)priority over the secured lender.
Accordingly, secured lenders prefer to take fixed charges where possible. Of course, fixed charges over some types of company assets - such as book debts- may be just impractical. A fixed charge over book debts could effectively prevent the company from using the money it recovers when it collects those debts.
In 1979, an English Court endorsed a device to get around this problem (the Siebe Gorman case). This depended upon notionally splitting a book debt from its proceeds. The lender would take a fixed charge over the book debts, but, as long as the company was a going concern, allow the company to use the proceeds of those debts for its business. There were a number of ways in which this was done, but they all included a fixed charge over the book debts and some different arrangement for the proceeds.
If the company went into liquidation, the secured lender would enforce its charge over the book debts. Because that was a fixed charge, it defeated the employees' claims.
Last Thursday evening (Australian time), the House of Lords ruled that these charges are really floating charges. The Law Lords effectively said that the notional split between a book debt and its proceeds was meaningless. The charges, they said, were really just floating charges over book debts, because of the way in which the lender allowed the company to retain control of the proceeds (National Westminster Bank plc v Spectrum Plus Ltd [2005] UKHL 41).
Australia
It was noticeable that the Law Lords had no hesitation in acknowledging that these charges are designed to defeat the claims of priority creditors. (In England, as well as employees, those priority creditors included the taxman, and it was the tax authorities who took this case to the House of Lords.)
The Law Lords reinforced the practical importance of this issue by noting that, in England alone, several hundred liquidations were on hold pending the outcome of the case.
We are not aware of any Australian liquidations which have been delayed because of this case. As mentioned above, the English decision is not binding on Australiancourts.
However, it is equally true that there is no definitive Australian case law on this issue. Two things follow from that:
It is also to be expected that Australian lenders will be revising their security documents in the light of this development.
