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Priority Employee Entitlements

How are employees affected by the insolvency of their employer?

Employees are usually the first creditors to be effected as their jobs will be at risk and there is a chance that some of their outstanding entitlements will not be covered by GEERS.

Employees are a special class of creditor because the failure of their employer will often terminate their only source of income. Their position can be contrasted with most other creditors, who are likely to have other customers and may have taken security or obtained personal guarantees to support their debts.

Because of this, both the Bankruptcy Act and the Corporations Act provide certain priorities for employee entitlements.

Who is an employee?

The definition of employee under the Corporations Act is:

"employee, in relation to a company, means a person:
(a) who has been or is an employee of the company, whether remunerated by salary, wages, commission or otherwise; and
(b) whose employment by the company commenced before the relevant date."

The Bankruptcy Act does not define employee, but gives priority to "amounts payable by way of allowance or reimbursement under a contract of employment or under an award or agreement regulating conditions of employment".

Usually it will not be difficult to determine if a person is an employee or an independent contractor. As a general rule services from a company, partnership or trust will not be regarded as having been supplied by an employee, especially if the service was supplied under an ABN. Some blurring of this definition occurs when a sole person gives full-time service to one customer as an independent contractor.

Does the Corporations Act or Bankruptcy Act apply?

This will depend on the legal status or identity the employer - whether the employer is a company, or an individual or partnership.

(a) If the employer is a company - the Corporations Act applies; and
(b) If the employer is a natural person(s) - or a business owned by a natural person(s) - the Bankruptcy Act will apply.

These two Acts deal with employee entitlements differently. Employees should be sure of the legal status of the employer when making a claim. If the employer is in administration under either Act, the external administrator will make this distinction clear to the employees.

Should employees provide TFN's?

Yes. Employees will have tax withheld from their dividends at the top marginal rate if a Tax File Number is not provided. Most employee proofs of debt provide a space for TFN's.

THE CORPORATIONS ACT

What priority does the Corporations Act provide?

Section 556 lists the priorities for dividends - including employee entitlement priorities - in a liquidation and, unless employees agree, in a Deed of Company Arrangement. This extract of section 556 should be read in conjunction with the remainder of the section, but it gives an indication of the priority provisions.

(e) subject to subsection (1A)--next, wages, superannuation contributions and superannuation guarantee charge payable by the company in respect of services rendered to the company by employees before the relevant date;
(f) next, amounts due in respect of injury compensation, being compensation the liability for which arose before the relevant date;
(g) subject to subsection (1B)--next, all amounts due:

(i) on or before the relevant date; and
(ii) because of an industrial instrument; and
(iii) to, or in respect of, employees of the company; and
(iv) in respect of leave of absence;

(h) subject to subsection (1C)--next, retrenchment payments payable to employees of the company.

Entitlements will be paid in the order of the priorities. Each level must be paid in full before any payment can be made on the next level. Any level not paid in full will be paid on a pro rata basis. Usually the priorities paid in most liquidations are:

• All wages and superannuation
• Leave entitlements
• Retrenchment payments

Who is an excluded employee?

The priorities are modified for some amounts owing to current and past directors, and for relatives of directors. These people are called excluded employees. Subsections (1A), (1B) and (1C) limit the amount available to an excluded employee to a statutory amount. The definition of an excluded employee is:

An excluded employee, in relation to a company, means:

(a) an employee of the company who has been:
(i) at any time during the period of 12 months ending on the relevant date; or
(ii) at any time since the relevant date;
or who is, a director of the company;

(b) an employee of the company who has been:
(i) at any time during the period of 12 months ending on the relevant date; or
(ii) at any time since the relevant date;
or who is, the spouse of an employee of the kind referred to in paragraph (a); or

(c) an employee of the company who is a relative (other than a spouse) of an employee of the kind referred to in paragraph (a).

Who else has priority under the Act?

A two other parties may obtain priority over trade creditors for employee entitlements. They are:

• GEERS - This is the government system that provides payment of most of the employee entitlements (excluding superannuation). GEERS is subrogated into the position of the employees when it makes payments to employees. They will be able to prove priority employee claims for the amounts paid.
• Section 560 gives people who provide money to the company for the payment of employee entitlements the same priority as the employee would have had if the money had not been provided and the employee could make a priority claim. This is essentially the same subrogation of the priority as GEERS.

THE BANKRUPTCY ACT

What priority does the Bankruptcy Act provide?

The Bankruptcy Act is different to the Corporations Act, although it has the same basic effect. It provides priority for employees entitlements, but only to a limited extent. Extracts from the main priority section of the Bankruptcy Act is set out below, but should be read in conjunction with the remainder of the sections.

Section 109

(e) fifth, in payment of amounts (including amounts payable by way of allowance or reimbursement under a contract of employment or under an award or agreement regulating conditions of employment, but not including amounts in respect of long service leave, extended leave, annual leave, recreation leave or sick leave), not exceeding in the case of any one employee $1,500 or such greater amount as is prescribed by the regulations for the purposes of this paragraph, due to or in respect of any employee of the bankrupt, whether remunerated by salary, wages, commission or otherwise, in respect of services rendered to or for the bankrupt before the date of the bankruptcy

(f) sixth, in payment of all amounts due in respect of compensation payable under any law of the Commonwealth or of a State or Territory relating to workers compensation, being compensation the liability for which accrued before the date of the bankruptcy;

(g) seventh, in payment of all amounts due to or in respect of any employee of the bankrupt, whether remunerated by salary, wages, commission or otherwise, in respect of long service leave, extended leave, annual leave, recreation leave or sick leave in respect of a period before the date of the bankruptcy;

Employees are only entitled to receive a limited amount of their wages entitlements as a priority, but their full amount of leave entitlements. Any amount above the wages limit will rank along side other creditors as non-priority. There is no priority for retrenchment payments.

GEERS

What is GEERS?

GEERS is a program for employees entitlements introduced in 2001 by the Department of Workplace Relations in response to some of the spectacular failures of major public companies. These failures left thousands of employees owed many millions of dollars in entitlements that they were never likely to receive. GEERS was put in place to make certain that some payments would be made to employees of insolvent employers.

To be able to make a claim under the scheme, employment must have been terminated due to the employer's insolvency - a liquidation in the case of a corporate employer. If the reason for the termination of employment is not insolvency, no claim will be possible.

The GEERS systems covers the following employee entitlements:

(a) All unpaid wages;
(b) All accrued annual leave;
(c) All accrued long service leave;
(d) All accrued pay in lieu of notice; and
(e) Up to 8 weeks redundancy entitlements (as per community standard)

Can every employee make a full claim?

No. You will have a limited claim if you:

(i) were a shareholding director or a relative of a shareholding director of the company;
(ii) are a defined relative of the former employer;

Amendments to the system in 2005 allow excluded employees of company, as defined by the Corporations Act, to receive the limited priority entitlements that they would be entitled to received by way of dividend in a liquidation. These amendments only apply to appointments commenced after their introduction.

You also cannot make a claim if you:

(i) were an independent contractor;
(ii) lodge your claim 12 months after your employment was terminated; or
(iii) resigned from your employment (in most cases).

How is a claim made?

The insolvency practitioner will calculate the entitlements owed to the employees and will determine whether there are sufficient funds available for payments of entitlements. If there are not sufficient funds, they will prepare a claim. Employee will need to complete a form to be submitted with the claim. This form sets out and verifies the claim made by the employee.

After payment of the claims, the Department will be substituted into the place of the employees and receive any dividend that would have been paid under the priority provisions.

UNPAID SUPERANNUATION

What about unpaid superannuation?

Employers are required to remit employer superannuation contributions by July 28 each year. If the employer fails to do so, they are expected to lodge a Superannuation Guarantee Statement with the ATO by the 14 of August of that year. If they do not do so, the ATO will be able to make a default assessment of outstanding superannuation. If the ATO makes an assessment of unpaid superannuation, default or otherwise, they can lodge a proof for the Superannuation Guarantee Shortfall.

The Superannuation Guarantee Shortfall can be made up of three components

1. The super not remitted;
2. A penalty; and
3. Interest

Who can prove for unpaid superannuation?

In simple terms, only the Australian Taxation Office who can lodge a proof of debt for outstanding statutory superannuation. Section 553AB of the Corporations Act provides that outstanding superannuation contributions are not provable if those contributions form part of a superannuation guarantee charge assessed by the Australian Taxation Office. There are only a few cases where an employee may also lodge a proof of debt for superannuation -

1. where the employer contributions are payable under a contract of employment rather than an Award or pursuant to the Superannuation Guarantee Levy. This would be unusual.

2. where what are claimed are Employee or Member Contributions into superannuation (not employer contributions) that have been deducted but not forwarded by the employer to the superannuation fund.

3. where, for whatever reason, the superannuation contributions outstanding will not form part of a superannuation guarantee charge.

It also appears that an employee can lodge a proof of debt for any agreed excess employer contributions over the minimum levy, but only if the ATO does not include these amounts in their claims. This is not confirmed in the legislation. There does not appear to be any circumstances where a Trustee of a Superannuation Fund can prove a claim in an estate. The rational for this is the Fund Trustee's duties are simply to hold the funds received on trust, rather than enforce any level of payment.

What priority is given to the superannuation guarantee shortfall?

The rules differ slightly under the Corporations Act and the Bankruptcy Act.

Under the Corporations Act, superannuation contributions and the superannuation guarantee charge are included in the same priority as wages. These will be paid in full or on a pro rata basis with outstanding wages. Excluded employees' superannuation (whether under the charge or not) is also included in section 556 and caught by the statutory limitation to their priority. That is, they will only be allocated $2,000 between wages, superannuation and the superannuation charge.

Under the Bankruptcy Act, the superannuation guarantee charge is also included in the same priority for wages, but is limited to the statutory level for all employees. Section 109 of the Bankruptcy Act gives a priority for amounts "due or in respect of any employee of the bankrupt" and includes unpaid superannuation due to section 109(1C).

The reference in paragraph (1)(e) to amounts due to or in respect of any employee of the bankrupt also includes a reference to amounts due as superannuation guarantee charge (within the meaning of the Superannuation Guarantee (Administration) Act 1992 ), or general interest charge in respect of non-payment of the superannuation guarantee charge.

That means that the statutory level will be dividend between outstanding wages and superannuation, including claims for excess contributions or contract contributions. Amounts above the statutory limit will be able to be claimed as a non-priority creditor.

For more detailed information:

Insolvency Resource Page: Employee Entitlements

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

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Last Updated: 12.2.2008