Employee entitlements (including wages, superannuation, leave, and termination amounts, etc.) are treated as a priority dividend—as a priority creditor in all insolvency appointments.
Fair Entitlements Guarantee Act 2012
On 5 December 2012, the Fair Entitlements Guarantee Act 2012 (FEG) commenced, as a legislative scheme to replace the General Employee Entitlements and Redundancy Scheme (GEERS). FEG assists employees who have lost their job because their employer entered into liquidation or bankruptcy. FEG operates in relation to claims for unpaid employee entitlements for employer liquidations and bankruptcies that occur on, or after 5 December 2012. GEERS continues to operate for claims that occurred before 5 December 2012.
Employees are usually the most affected creditor when their employer becomes insolvent. Their jobs are at risk and their outstanding entitlements may not be recovered, or that receiving payment (even under FEG) will take a long time. Unlike other creditors that largely have income from other sources, and may have a security or personal guarantee to support their debts. The Corporations Act 2001 provides employees certain priorities in consideration of these conflicting positions. The FEG provisions, in some circumstances, also provide payments to employees.
Often the priorities are of no consequence as there are no assets to cover employee entitlements, so the Federal Government assists employees under FEG/GEERS when there is insufficient money to satisfy their entitlements.
FEG was set up to ensure that employees of insolvent employers are paid at least some of their entitlements.
The scheme is designed to cover the payment of outstanding wages, leave and redundancy payments on the insolvency of the employer. FEG specifically excludes payment of outstanding superannuation. It also excludes the entitlements of directors, or relatives of directors, and individuals defined as ‘excluded employees’ under section 556 of the Corporations Act.
The scheme provides assistance with the following employee entitlements:
- Wages—up to 13 weeks of unpaid wages.
- Accrued annual leave.
- All long service leave.
- Payment in lieu of notice (up to 5 weeks).
- A limited amount of redundancy (where a legal entitlement exists)—up to 4 weeks per full year of service.
The employee must have been terminated because of the insolvency of the employer (liquidation or bankruptcy). Any employee terminated for other reasons, even if owed money at the time of an insolvency practitioner appointment, is not eligible to claim under FEG.
FEG decide whether an employee has a claim, and decide on the payment amount. Employees must show they are an employee, and not a contractor. FEG requires documents to support their claim such as, an employment contract or agreement and pay-slips detailing start dates and normal wages.
FEG’s strict review process requires the insolvency practitioner to verify the employee’s entitlement and relevant contracts or awards. FEG then verifies the claims and can result in sometimes significant adjustments (as records may differ) to employees’ claims. Once FEG and the insolvency practitioner agree, FEG will distribute to employees.
FEG has its own ‘excluded employee’ classification, which is, in essence the same as the Corporations Act’s classification. FEG does not pay excluded employees (relatives of a director under the Corporations Act), regardless of the limits set for excluded employees under the Corporations Act. An employee may have a claim against the company (subject to the limits) but if the company does not have the funds to pay these, FEG will not pay those entitlements.
Who is an ‘employee’?
It is important to determine exactly who is an employee. The relevant definition of employee in section 556 of 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 1966 does not define ‘employee’, but are in effect are described in the same terms with a 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 is easy to determine if a person is an employee or a contractor. As a general rule, services supplied by a company, partnership and trust are not regarded as been supplied by an employee. It is clear when the service is supplied under an ABN.
Which Act applies?
Whether the Bankruptcy Act or the Corporations Act applies depends upon the legal form of the employer—a company or an individual or partnership etc.
- If the employer is a company—the Corporations Act applies.
- If the employer is a natural person–or a business owned and run by a natural person–the Bankruptcy Act will apply.
These two Acts deal with employee entitlements differently, with different priorities to different amounts. To make a claim, employees must be certain of their employer’s legal form. The insolvency practitioner should provide the appropriate proof of debt to employees to complete.
The Corporations Act
Employees are generally owed entitlements when a liquidator is appointed. Some entitlements will be outstanding wages that are owing immediately, but some may be leave payments that are not, in the usual course, payable. The Corporations Act deems all employee entitlements are payable when a liquidator is appointed, giving employees the right to claim for outstanding leave (annual/long service). These amounts then form part of the payments to employees. Section 556 of the Corporations Act gives priorities for dividends to company employees. Employees are entitled to be paid their full entitlements, before other unsecured creditors. For a comprehensive understanding of the priority provisions, section 556 should be read in full.
In summary priorities are in the order of:
- Wages, superannuation contributions, and any superannuation guarantee charge.
- Leave entitlements.
- Retrenchment payments.
One of the differences between the two Acts are the Corporations Act requires employee entitlements to be paid in full before any other creditor is paid (subject to any circulating creditor claims under section 561). The Bankruptcy Act sets limits on the amount of priority given to employees.
Each separate employee entitlement is a separate class and forms a separate priority to be paid in that particular order. Each class of entitlement must be paid in full before the next class of entitlement may be paid (i.e. wages must be paid in full before any leave entitlements are paid). All priority employee entitlements must be paid in full before unsecured creditors receive a dividend.
The Corporations Act defines excluded employees as officers of the company, and their relatives. Although they are employees and have access to the priorities, for some entitlements, they have a statutory limit on the priority amount. For the entitlements not covered by the Corporations Act, these amounts become non-priority debt that are claimed alongside other unsecured creditors.
Currently, excluded employees can claim $2,000 for wages/superannuation and $1,500 for leave entitlements. Also, they can claim a retrenchment entitlement, but only for the amount attributed to when they were not excluded employees. In practice, this means that relatives of directors are unable to claim retrenchment compensation, unless their status changed during their employment.
The Bankruptcy Act does not have similar provisions, for employees related to the bankrupt.
Carrying forward of employee entitlements
The liquidator may continue to trade the business and therefore retain the employees. A trade-on can be for days, or for months. Holiday, long service, and retrenchment entitlements are based on the length of employment. These entitlements are factored into the administration costs, and not as a distribution and is a cost payable under section 556(1)(a) of the Corporations Act.
The liquidator will determine what amount of the entitlement relates to the period of employment and pay that amount before declaring a dividend.
Payments to employees by third parties
Section 560 of the Corporations Act identifies that when a third party advances funds to a company to pay its wages and other employee entitlements they can ‘stand in the shoes’ of the employees. Thereby receiving the same priority that employees would receive if those payments were not made, but only to the amount they advanced.
When secured creditors exercise their securities, they can generally bypass the insolvency process. However, the Corporations Act allows priority to employees, over assets subject to securities in either a liquidation or receivership scenario.
These provisions relate only to recoveries made from the realisation of circulating assets of a PPSA security (debtors and stock-in-trade etc). Recoveries from non-circulating assets will not be affected by this section. They will be available in full to the secured creditor.
Assets secured by a circulating security may be affected. Section 560 grants a priority to employees over those floating assets to the amount sufficient to pay wages and superannuation, leave entitlements, and redundancy entitlements to employees—or to a third party that received priority.
Section 560 gives the liquidator power to use floating assets to satisfy employees’ claims. Secured creditors will not be paid from circulating assets until the liquidator has retained sufficient funds to pay these entitlements.
Receivers and managers are also bound by the same type of priorities in part 5.2 of the Corporations Act. There are occasions when a receiver is acting but no liquidator has been appointed. If a controller is appointed before a liquidator, the Act obligates the controller to pay these entitlements.
The controller’s priorities and limits are different to a liquidator’s. The controller provisions do not include section 558 that activates all leave entitlements. Controllers only pay leave entitlements that are approved and due for payment at the time of their appointment. If the leave amounts are not approved by the company for payment before the appointment, they are not under the controller’s priority.
The result of these two sections is that some employee entitlements will have priority over the secured creditor regardless of which insolvency practitioner is appointed. The balance of entitlements can be paid by a liquidator from any assets not subject to a security, or any surplus.
The Bankruptcy Act does not have any provisions granting priority over secured creditors claims to assets.
The Bankruptcy Act
The Bankruptcy Act deals with employee claims differently to the Corporations Act, although they still provide employees with priorities over unsecured creditors.
In summary, the Bankruptcy Act sets the following priorities:
- Wages, some superannuation or other amounts due with some exceptions—to a limited of $4,450. This amount is linked to CPI and current indexed amounts released by the Australian Financial Security Authority.
- Injury compensation and has no limitation.
- All types of leave entitlements with no limitation.
Any amount not covered by the limited priority provisions can be claimed as a non-priority claim alongside other non-priority unsecured creditors.
The Bankruptcy Act does not have an ‘excluded employee’ classification, so employees related to the bankrupt are treated the same as other employees. There are no special provisions for an employee entitlement to have priority over secured creditor claims on assets. A secured creditor is not concerned with employee entitlements.
Payments to employees by third parties
When a third party advances funds to a company to pay its wages and other employee entitlements, they have the right to be repaid. This third party can ‘stand in the shoes’ of the employees and thereby receive the same priority that employees would receive if those payments were not made, but only to the amount they advanced.
The third party can claim for any shortfall from the priority amount as a non-priority creditor—their rights are also limited to the statutory limit on wages. Importantly, the advancement must be made prior to bankruptcy, for the intended purpose.
Carrying forward of employee entitlements
The trustee may continue to trade the business and therefore retain the employees. A trade-on can be for days, or for months. Holiday, long service, and retrenchment entitlements are based on the length of employment. These entitlements are factored into the administration costs, and not as a distribution and is a cost payable under section 109(1)(a) of the Bankruptcy Act.
The trustee will determine what amount of the entitlement relates to the period of employment and pay that amount before declaring a dividend.
Employers must remit employer superannuation contributions to relevant funds within 28 days after the end of each quarter. If an employer fails to remit, they must lodge a Superannuation Guarantee Statement (SGS) with the Australian Taxation Office (ATO). The ATO can make a default assessment if this statement is not lodged.
If the employer is subject to an insolvency administration, the ATO may lodge a proof of debt with the insolvency practitioner for the Superannuation Guarantee Shortfall (assessment, default or otherwise). The SGS, which makes up the Superannuation Guarantee Charge (SGC), can be made up of three components:
- the superannuation amount unremitted
- a penalty
Who can prove for unpaid superannuation?
The employer must deduct an amount for superannuation and pay to the employee’s superannuation fund. The statutory superannuation amount is not technically a debt to the employee, and is not provable by the employee if it falls under a claim made by the ATO under the Superannuation Guarantee provisions (see below). Also, technically it is not a debt due to the superannuation fund trustee.
Section 553AB of The Corporations Act provides priority to the ATO’s proof of debt over an employee’s or superannuation fund trustee’s proof of debt.
An employee can lodge a proof of debt for superannuation in the limited cases following:
- Where the employer contributions are payable under a contract of employment, rather than an award or pursuant to the Superannuation Guarantee Levy.
- Where the claim is for unremitted employee contributions (as opposed to employer contributions) under a salary sacrifice arrangement.
- Where the outstanding superannuation contribution, for whatever reason (catch-all for other possible scenarios) does not form part of a SGC lodged by the ATO.
The Corporations Act, states that only the ATO can lodge a proof of debt for unpaid superannuation if it falls under the Superannuation Guarantee Charge—whether a claim has been made, or not. When the ATO has the right to make a claim for the SGS, no one else can make that claim.
Superannuation guarantee shortfall
The rules differ slightly under the Corporations Act and the Bankruptcy Act when it comes to the priority of the Superannuation Guarantee debt, or any claim that may be made by the employee or their superannuation fund trustee.
Under the Corporations Act any superannuation not remitted (contributions or superannuation guarantee charge) has a priority under section 556(1)(e), with superannuation specifically noted as a priority entitlement.
The superannuation amount is subject to the limit for excluded employees under section 556 (1A) of the Corporations Act. Previously it was determined that superannuation claimed is a claim payable to the ATO, not as an employee entitlement (payable to the employee), and not subject to the limitation—therefore claims related to excluded employees could be paid in full. This position changed on 1 January 2008 with a change in the wording of the legislation in section 556(1E) of the Corporations Act.
The Bankruptcy Act gives priority for amounts due to the bankrupt’s employees. Section 109(1C) includes any outstanding SGC (which includes interest and penalties) as part of that priority amount.
Therefore, any superannuation amount claimed and proved for by the ATO is subject to the upper priority limit imposed by the Bankruptcy Act. The balance of superannuation guarantee charge would then be a non-priority debt along with the balance of the wages amount.
Claims by employees for excess contributions or contract contributions have the section 109 priority, as they are due in respect of an employee and for services rendered, but are also subject to that limited priority.
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.
Last Updated: 18.11.2015