Security trumps priority

A recent Supreme Court of Queensland judgement has cemented the long-established principle of secured creditors retaining the proceeds (ahead of claims by priority creditors) of any funds advanced to a company in receivership in order to facilitate a trade-on of the business. As those familiar with the corporate insolvency industry would be well aware, the claims of employees (amongst other things) are sometimes required to be paid ahead of the secured creditor(s). Ordinarily, Secured Creditors are entitled to claim the proceeds of any secured debts, however the operation of Section 433 (Receivership) and Section 561 (Liquidation) of the Corporations Act formalise the requirement to pay out employee claims prior to the payment of secured creditors (reference available upon request) from assets secured by a circulating security interest.

The case in question concerns an automotive components manufacturer, CMI Industrial Pty Limited which had gone into receivership and was later placed into Liquidation. Upon their appointment by the first-ranking secured creditor, the receivers undertook to continue to trade the business of the company by purchasing raw materials and producing saleable inventory. The receivers were successful in this regard and produced a significant cash surplus. The Liquidators, following their subsequent appointment contended that these proceeds, in addition to the other assets of the company were subject to the provisions of Section 433 of the Act which accords priority to the employees of the Company.

The established view of the operation of this statue is that it creates an obligation on the part of the receivers to employ the assets of the company as identified on the date of the appointment of the receiver. Any assets forwarded to the Company following the appointment of a receiver, such as cash forwarded by a Secured Creditor to enable the trading-on of the business, would not be subject to the provisions of S433 (awarding special priority to employees) , which infers that the proceeds of such actions would necessarily flow back to the Secured Creditors.

Fortunately for lenders, Justice Mullins did not contravene the existing precedence and found in favour of the Secured Creditors. In her judgement she found that the Liquidator’s contention that assets acquired by the Company following the appointment of a receiver were subject to the provisions of S433 was unfounded. Justice Mullins noted that the extent of the assets available for distribution to priority creditors extends from the definition set out in S433(2)(a) which operates from the date of appointment of a receiver (reference available upon request). Accordingly, any assets acquired following the appointment of a receiver would not be subject to S433 and should be distributed to the Secured Creditor.

This decision reaffirms the established principle held by many in the insolvency industry that any funds generated by the trading-on of a business following the appointment of a receiver should not be subject to the provisions of S433. This should provide some assurance to secured creditors looking to take an active role in the recovery of debts in a receivership scenario whilst providing a clearer outline of the funds required to be paid in respect of employee claims.