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Creditor Types and Rankings

Posted by Revive Financial on May 1, 2015 12:00:00 AM

If a company owes you money, taking an interest in its liquidation may help you secure a better financial return.

The recent Australian Federal court case[1] highlighted why it’s important for creditors to participate in the liquidation process instead of just sitting on the sidelines assuming the game is over.

Whether you’re an employee owed wages by a company in liquidation, or a supplier seeking payment from an outstanding debtor on the brink of external administration, if a company owes you money you’re a creditor of that company.

So here’s an overview of your rights and obligations during insolvency.

Types of Creditors

Creditors are divided into two separate categories:

  • Secured
  • Unsecured

Who gets paid first when the debtor company becomes insolvent depends on each creditor’s priority status. It ultimately determines the dividend when a company is wound up, or what’s payable under a Deed of Company Arrangement (in the case of a voluntary administration).

Knowing the primary differences between the types of creditors can help you understand and engage in insolvency processes for your own benefit.

Secured Creditors

A secured creditor is someone who has a security interest (such as a mortgage or a charge) over some or all of the company’s assets to secure a debt owed by the company.

If the company defaults on its obligations under a security interest, a secured creditor can appoint an independent, qualified receiver to take control and realise some or all of the secured assets to satisfy the secured creditor’s debt. The assets must be sold at market value (or at least the most reasonably attainable price) .

A secured creditor can:

  • vote at creditors’ meetings for the amount the company owes them that exceeds the amount they’ll likely get from realising the secured assets
  • participate in any dividend to unsecured creditors on a similar basis.

Unsecured Creditors

Unsecured creditors rank lower than secured creditors because they have no ‘security’ over company assets. Unsecured creditors can include companies that sold goods or services to the company (i.e. suppliers) and the Australian Taxation Office.

Once the creditor has lodged a proof of debt, they’ll need to wait for the liquidator to finish their investigation. The funds are used initially to pay the liquidator’s fees and costs, and then to pay priority creditors such as employees and secured creditors. (If there are insufficient funds to pay the priority creditors in full, they’re paid on a pro rata basis.) Once that’s done, any remaining monies will be distributed to unsecured creditors as a dividend payment.

Unfortunately, there’s no guarantee creditors will get paid at all. In certain cases, there will be no money (or only a percentage) left in the pool to satisfy creditor claims.

Priority Unsecured Creditors

So what happens to the employees when the company becomes insolvent? Facing unemployment is bad enough without having to worry about whether or not they’ll receive their outstanding entitlements.

Fortunately for them,they’re considered a special class of unsecured creditors, with a higher priority than other unsecured creditors. They have priority over the floating assets of the company (or those assets secured by ‘circulating security interests’) of secured creditors.

Section 556 of the Corporations Act 2001 (Cth) (Act) lists the priorities for dividends in a liquidation, including employee entitlement priorities. Generally, employees of the company have a statutory priority of payment with respect to outstanding entitlements (once the liquidator’s fees have been paid). These include (in order of priority):

  • wages and superannuation contributions
  • personal injury compensation (if owing)
  • leave entitlements (i.e. annual leave/holiday pay, personal leave (sick pay) and long service leave)
    redundancy payments.

The only exceptions are ‘excluded employees’--those employees who were a director (or a relative/spouse of a director) in the 12 months before the liquidation. Excluded employees are subject to a priority cap of:

  • $2,000 for unpaid wage and superannuation entitlements
  • $1,500 for leave entitlements.

The balance of entitlements are then given the same priority as ordinary unsecured creditors.

The Fair Entitlements Guarantee (FEG) Act 2012

For employees who lose their jobs when:

  • their employer company goes into liquidation
  • the company has exhausted its funds (or it will take a long time for liquidator to realise assets)

The Federal Government also offers the FEG legislative scheme (previously the General Employee Entitlements and Redundancy Scheme, or GEERS).

Subject to eligibility requirements, this Department of Employment (DOE) safety net scheme can offer funding relief by paying leave entitlements, wages, payment in lieu of notice and redundancy entitlements. (The scheme doesn’t cover superannuation.)

FEG will operate for employer liquidations and bankruptcies occurring on or after 5 December 2012, while GEERS will keep operating for insolvencies before 5 December 2012. For any monies paid out by DOE under the GEERS and FEG schemes, DOE are given the same priority as employees in the liquidation setting.

(For more information, see our FEG scheme.)

The Creditors’ Rights During Liquidation

When a company enters into liquidation, creditors often feel frustrated, uninformed and ‘out of the loop’. They feel they have little control over the insolvency process and decisions made by the liquidator.

So creditors should know they have the right to:

  • submit a proof debt to the liquidator (with invoices and other supporting evidence to prove the existence of the debt)
  • ask the liquidator questions about the status of the liquidation, and inform the liquidator about their knowledge of the company’s affairs
  • ask the liquidator to call a creditors’ meeting at times other than specified under the Act (provided they cover the costs)
  • vote at creditors’ meetings, or appoint proxies to attend and vote on the creditor’s instructions
  • receive written liquidation reports
  • inspect certain books
  • complain to the Australian Securities and Investments Commission or the court about the liquidator’s conduct.

Dealing with corporate insolvency can be a confusing and complex process. As Insurance Australia Limited (IAL) discovered in the Robinson case, providing valuable information and litigation funding assistance and being actively involved can lead to a better result. Get in touch with us for a confidential consultation.

For more information on Company Liquidation, check out our Company Liquidation page here. 

[1] Robinson, in the Matter of ACN 069 895 585 Pty Ltd (formerly known as Waterman Collections Pty Ltd) (in liq) [2013] FCA 706

Topics: Company Liquidation

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