House of Representatives

Explanatory Memorandum

(Circulated by authority of the Assistant Treasurer, the Hon Stuart Robert MP)

Chapter 3

Contribution orders

Outline of chapter

3.1 Part 2 of Schedule 1 to the Bill inserts new provisions into Part 5.7B of the Corporations 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.

Context of amendments

3.2 Many businesses operate using a group structure comprising several companies, with a parent company controlling the group, and each company in the group being a separate legal entity with limited liability. Such groups are often referred to as 'company groups' or 'corporate groups'.

3.3 Corporate groups can structure themselves in a multitude of ways. A group can legitimately be structured so that one or more companies in the group hold the employees and associated liabilities while other companies in the group hold the assets of the group.

3.4 Where corporate groups adopt such structures and legally operate as if they are a single unit or entity (for example, by all the entities in the group entering a deed of cross guarantee for all the group's liabilities), the insolvency of a group member with employee entitlement liabilities may not adversely impact the ultimate payment of those entitlements because the insolvent member can draw on the guarantee.

3.5 Where corporate groups do not enter into a 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, even if there are funds within the corporate group to pay them.

3.6 In some cases, other entities in the corporate group will have obtained economic benefits from the work carried out by the employees of the now insolvent group member, but these other entities might not have been charged the full arm's-length value of the benefit they obtained.

3.7 Insolvency of entities in such circumstances can have the consequence of inappropriately shifting the costs of the corporate group's outstanding employee entitlement liabilities to the FEG scheme.

3.8 Further to corporate groups, companies can flexibly use other companies to employ and pay employees who provide services on behalf of the first company. Companies can also flexibly use other types of entities, such as partnerships or trusts, to operate specific parts of a business or to structure their assets and liabilities. In many instances, these groupings of entities have such a close economic and commercial relationship that they effectively function as a single entity.

3.9 In these circumstances, some entities may have obtained economic benefits from the work carried out by the employees of the now insolvent company, but might not have been charged the full arm's-length value of the benefit they obtained.

3.10 The Bill introduces new provisions into the Corporations Act to address the circumstances where an insolvent company has unpaid employee entitlements, and there are funds held by other entities within the larger corporate group, or in a closely connected economic relationship with the insolvent company, that have unfairly benefited from the work of those employees. These provisions are similar to those which exist in New Zealand's Companies Act 1993 (NZ). They allow contributions to be sought from entities across a corporate group or entities with a closely connected economic relationship, for the payment of outstanding employee entitlements of insolvent corporate entities in appropriate circumstances.

Summary of new law

3.11 Part 2 of Schedule 1 to the Bill inserts new provisions into the Corporations Act that will allow recovery of unpaid employee entitlements of an insolvent company from certain entities in limited circumstances.

3.12 In summary, the amendments provide that:

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a liquidator (and, in certain circumstances, the ATO, FWO, and DJSB) will be able to seek an 'employee entitlements contribution order' that requires an entity within the same 'contribution order group' as an insolvent company to contribute to the payment of the insolvent company's employee entitlement liabilities where:

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it is 'just and equitable'; and

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the entity has benefited, directly or indirectly, from the labour of the employees of the insolvent company on other than arms-length terms;

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the scope of the 'employee entitlements contribution order' is limited to the entitlements protected under Part 5.8A; and

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the Court will determine, as part of the proceedings:

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the existence and composition of a 'contribution order group';

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the value of the 'benefit' that the contributing entity received, and whether it provided arm's length consideration for that benefit; and

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whether making the contribution order is 'just and equitable'.

Comparison of key features of new law and current law

Detailed explanation of new law

3.13 Part 2 of Schedule 1 to the Bill makes amendments to the Corporations Act to insert new provisions which will allow the Court to make an 'employee entitlements contribution order' that requires an entity or entities in the same 'contribution order group' as an insolvent company to contribute to the payment of the employee entitlement liabilities of the company where:

•

the entity has benefited from the labour of the employees of the insolvent company on other than arms-length terms; and

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it is 'just and equitable' to make the order.

3.14 Part 2 of Schedule 1 to the Bill inserts new Division 8 into Part 5.7B of the Corporations Act.

Subsection 588ZA - Employee entitlements contribution orders

3.15 Under section 588ZA, the Court can make an order (an 'employee entitlements contribution order') requiring an entity within a 'contribution order group', to contribute, in certain circumstances, to the payment of the employee entitlement liabilities of an insolvent company in the same contribution order group. [Schedule 1, item 20, subsections 588ZA(1), (2) and (6)]

3.16 A definition of 'employee entitlements contribution order', which is taken to have the meaning given by subsection 588ZA(1) of the Corporations Act, has been inserted into section 9 of the Corporations Act. [Schedule 1, item 19, section 9]

When the Court can make an employee entitlements contribution order

3.17 The Court needs to be satisfied of the things specified in paragraphs 588ZA(1)(a) to (f) before it can make an employee entitlements contribution order.

First requirement - a company is being wound up

3.18 The first requirement is the Court must be satisfied that a company (the 'insolvent company') is being wound up. Winding up can be established by showing that, for example, a company's creditors have resolved to wind up the company and a liquidator has been appointed. [Schedule 1, item 20, paragraph 588ZA(1)(a)]

Second requirement - outstanding employee entitlements

3.19 The second requirement is the Court must be satisfied at the time of making the order that the insolvent company has unpaid employee entitlements of the type within the meaning of Part 5.8A of the Corporations Act. [Schedule 1, item 20, paragraph 588ZA(1)(b)]

3.20 The employee entitlements that can be the subject of a contribution order are the same employee entitlements that would receive preferential payment in a winding up.

3.21 It is open to the Court to rely on reasonable estimates by the liquidator of the debts owed by the company to its former employees. This would relieve liquidators from having to complete the formal proof of debts process for the company prior to an application for an employee entitlements contribution order being made to the Court.

Example 3.1

Brian is appointed as the liquidator of Hatchback Pty Ltd, a parcel delivery company. Due to the way the company operated, Brian is considering applying to the Court for an employee entitlements contribution order, however no books and records of the company are able to be located, because they have been destroyed.

As part of his investigations, Brian examines the company's bank accounts, and contacts the ATO to obtain information about payments made to employees by the company. Additionally, Brian verifies information for the DJSB for the payment of FEG to former employees of Hatchback Pty Ltd.

Using the information collected, Brian is able to construct a reasonable estimate that the amount of unpaid employee entitlements is $3 million.

Third requirement - contributing entities and contribution order group

3.22 The third requirement is the Court must be satisfied that the contributing entity is a member of the same contribution order group as the insolvent company. [Schedule 1, item 20, paragraph 588ZA(1)(c)]

3.23 Subsection 588ZA(6) lists six tests which the Court can use to determine whether two entities (one of which must be the insolvent company) are members of the same contribution order group. [Schedule 1, item 20, paragraphs 588ZA(6)(a) to (f)]

3.24 These tests are designed to capture different types of corporate groups, and diverse and sophisticated business structures used by sharp corporate operators. The tests are largely based on established principles commonly used to determine corporate control, and tax and financial reporting obligations. While the concept of a contribution order group is broad reaching in its application, the provisions contain appropriate safeguards as the entity in the group must have benefited from the employees' labour on other than arms-length terms, and the Court must be satisfied the order is just and equitable.

3.25 With the first two tests outlined in paragraphs 588ZA(6)(a) and (b) (which relate to related bodies corporate), the Court would consider whether the entities are or were related to one another, for example, because they are subsidiaries with the same holding company, or where one entity is a subsidiary or holding company of the other entity (see section 50 of the Corporations Act, which sets out the meaning of related bodies corporate).

3.26 With the third test in paragraph 588ZA(6)(c) (which relates to control relationships between entities), the Court would consider whether an entity currently has, or previously had, the capacity to determine the outcome of decisions about another entity's financial and operating policies (see section 50AA of the Corporations Act, which outlines when an entity controls a second entity).

3.27 The fourth test outlined in paragraph 588ZA(6)(d) (the entities both represent or have represented to the public that they are related to one another) 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.

3.28 In determining whether the entities have represented to the public they are related to one another, the Court could consider:

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promotional material and other business documents published by the relevant entities;

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information in documents lodged with ASIC or other Government entities;

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communications between the entities and employees and other stakeholders of the entities; and

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annual reports of the relevant entities.

3.29 The fifth test outlined in paragraph 588ZA(6)(e) (both entities are, or have been, part of the same consolidated entity) captures entities in consolidated groups for accounting and financial reporting purposes (see the definition of 'consolidated entity' in section 9 of the Corporations Act). For the purposes of this test, the Court could consider materials such as:

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consolidated accounts prepared according to relevant accounting standards in the current and previous years;

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financial reports and other documents lodged with ASIC related to the relevant entities; and

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materials provided to financial institutions for purposes of financing for the consolidated entity.

3.30 With the sixth test outlined in paragraph 588ZA(6)(f) (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), the Court could consider examining the legal, commercial and operating structures of the group of entities, as well as the day-to-day operation of the businesses, to make a determination as to whether entities operated in this way.

3.31 For entities to operate as, or comprise, a single entity, they need to operate closely together to achieve a set of common aims. The more integrated the operation of the entities, the more likely they will be operating as a single entity.

3.32 For example, if each of the entities supported each other to achieve a common aim and the employees of the different entities worked together on common tasks, or if the assets and employees of an entity were held by separate entities in a group, but the employees worked with the assets to derive profits ultimately for the group, it would be more likely the entities would be operating as a single entity.

3.33 Conversely, if a group of entities operated relatively independently and were not intertwined in their operations, the entities would less likely be functioning as a single entity.

Example 3.2

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).

3.34 The Court need only apply one of the six tests to determine that two entities are members of the same contribution order group.

Fourth requirement - contributing entity benefited from the work done by employees of the insolvent entity

3.35 The fourth requirement is the Court must be satisfied that the contributing entity has benefited, directly or indirectly, from work done by the employees of the insolvent entity. [Schedule 1, item 20, paragraph 588ZA(1)(d)]

3.36 The Court may examine the entities which make up the 'members of the same contribution order group', and determine whether they received any benefits. Only entities that receive benefits can be 'contributing entities'.

3.37 In determining whether the contributing entity has benefited from the work done by employees of the insolvent company, the Court could consider which entities in the contribution group the employees did work for, and which entities made payments for that labour.

Fifth requirement - benefit exceeds that which is reasonable in the circumstances

3.38 The fifth requirement is the Court must be satisfied 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. [Schedule 1, item 20, paragraph 588ZA(1)(e)]

3.39 To be satisfied of this requirement, 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. The following factors could be considered by the Court in making a determination of the excess benefit:

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the price other entities in the contributing group, or a similar industry, pay for the work done by the employees;

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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;

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any other dealings or offset type arrangements between the entities.

Example 3.3

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.

Sixth requirement - it is just and equitable to make the order

3.40 The sixth requirement is the Court must be satisfied that it is just and equitable to make the order in the particular case. [Schedule 1, item 20, paragraph 588ZA(1)(f)]

3.41 To assist the Court in making a determination that it is just and equitable to make an order, subsection 588ZA(4) outlines a number of factors that the Court may have regard to. These factors are:

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the size of the excess benefit obtained by the contributing entity referred to in paragraph 588ZA(1)(e) (for example, if the benefit is nominal or immaterial or significant in nature);

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the nature of the relationship between the contributing entity and the insolvent company;

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any efforts made by the potential 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;

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if the potential contributing entity is solvent, whether the order is likely to result in the contributing entity becoming insolvent;

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the extent (if any) to which the order is likely to result in the contributing entity becoming unable to pay the entitlements of its own employees or make distributions to its creditors; and

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any other matters that the Court considers are appropriate.

[Schedule 1, item 20, paragraphs 588ZA(4)(a) to (f)]

3.42 Matters the Court could consider under paragraph 588ZA(4)(f) could include:

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the control and management relationship between the members of the contribution order group, and whether the insolvent entity had common officers with some or all of the other members of the contribution order group; and

•

efforts made by other members of the same contribution order group to avoid or prevent the making of a contribution order, such as by transferring assets from entities which received an excess benefit from the employee labour so that a contribution order would make the entity insolvent (note that paragraph 588ZA(4)(c) provides that the Court may have regard to whether making a contribution order is likely to result in the contributing entity becoming insolvent).

The Court may order a contributing entity to pay the liquidator

3.43 The Court may order the contributing entity to make a payment to the liquidator of the insolvent company that reflects the additional non-arm's length benefit obtained by that entity. This benefit is the excess amount referred to in paragraph 588ZA(1)(e), and is calculated as the difference between what was directly or indirectly paid for the benefit and what 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. [Schedule 1, item 20, paragraph 588ZA(2)(a)]

3.44 The contribution order cannot exceed the unpaid employee entitlements of the insolvent company which are protected under Part 5.8A of the Corporations Act. [Schedule 1, item 20, paragraph 588ZA(2)(b)]

Example 3.4

Cabernet Pty Ltd had outstanding employee entitlements of $75,000 as a result of being wound up.

The Court determines the value of the extra benefit which Semillon Pty Ltd and Merlot Pty Ltd received due to them not dealing at arm's length with Cabernet Pty is $100,000.

The Court is satisfied of the other requirements in subsection 288ZA(1), and that it is just and equitable to make the order. However paragraph 588ZA(2)(b) limits the amount that Semillon Pty Ltd and Merlot Pty Ltd can contribute to the unpaid entitlements of Cabernet Pty Ltd to $75,000. The additional $25,000 benefit which Semillon Pty Ltd and Merlot Pty Ltd received, is not recoverable because it would exceed the amount of the outstanding employee entitlements.

Amount paid under a contribution order does not have priority

3.45 When a contributing entity pays the amount owing under the contribution order, this payment is not to be taken to be an advance of money for the purposes of section 560 of the Corporations Act. [Schedule 1, item 20, subsection 588ZA(3)]

3.46 Without this provision, a contributing entity could claim that the payment of a contribution order is an advance on account of wages or other employee entitlements, and the contributing entity could then seek to be repaid the amount as a priority creditor in the winding up of the company.

The Court has discretion to give effect to a contribution order

3.47 Where a contributing entity is a company, the Court has the discretion to order that an amount that the company has to pay under the contribution order, is to be treated, if the company eventually enters into winding up, as a priority employee entitlement under section 556 owing to the liquidator. [Schedule 1, item 20, paragraph 588ZA(5)(a)]

3.48 Additionally, the Court may make any orders and give any directions that the Court believes are necessary to give effect to a contribution order, and to ensure it is paid to the insolvent company's liquidator. [Schedule 1, item 20, paragraph 588ZA(5)(b)]

Section 588ZB - Applying to the Court for an employee entitlements contribution order

3.49 A Court can make an employee entitlements contribution order on receiving an application for such an order from:

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the liquidator of the insolvent company;

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the ATO;

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the FWO; or

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the Secretary of the Department administering the Fair Entitlements Guarantee Act 2012 (Cth).

[Schedule 1, item 20, subsection 588ZB(1)]

3.50 The liquidator of the insolvent company does not require permission from any party before making an application to the Court for an employee entitlements contribution order and is usually the primary person who would seek such an order. However, to provide flexibility in the operation of these provisions should the liquidator fail to or be unable to commence proceedings seeking a contribution order (for example, because the liquidator is not adequately funded), the government bodies mentioned in subsection 588ZB(1) may also commence proceedings subject to the requirements in subsection 588ZB(2).

3.51 The listed government bodies can only seek employee entitlements contribution order where they have either obtained the written consent of the liquidator or have obtained the leave of the Court. [Schedule 1, item 20, subsection 588ZB(2)]

3.52 In cases where the liquidator does not commence proceedings, the Court can grant leave to any of the government bodies to make an application for an employee entitlements contribution order. Before leave can be granted, the government body needs to request the liquidator's consent to make an application. If more than 30 days have passed since the government body made the request and the liquidator has not provided consent, or the liquidator has decided not to give consent, the Court can, if satisfied it is appropriate to do so, grant leave for the government bodies to commence the proceedings. [Schedule 1, item 20, subsection 588ZB(3)]

3.53 In determining whether it is appropriate to grant leave, the Court may have regard to:

•

whether the liquidator is likely to make an application for an employee entitlements contribution order; and

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any other matters the Court considers relevant in each case.

Time limits for making an application for a contribution order

3.54 An application for an employee entitlements contribution order must be made within six years after the beginning of the winding up of the insolvent company. [Schedule 1, item 20, subsection 588ZB(4)]

Consequential amendments

3.55 There are no consequential amendments.

Application and transitional provisions

3.56 The provisions will apply from the day after Royal Assent, and will apply in relation to the winding up of a company (the insolvent company) that begins at or after commencement of the provisions. [Schedule 1, item 33, section 1648]