Key takeaways:
- Employee Entitlement Contribution Orders can require one group company to assume liabilities of another.
- Any assumed liabilities should be treated as potential priority claims: the EECO may establish a preferential entitlement to circulating assets and their proceeds.
- This could cut across conventional ABL structuring and needs to be borne in mind by ABL lenders.
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In our March update, Asset backed lending – What else might your business have to offer we highlighted that market conditions were ripe for Asset Backed Lending products to come to the fore. The cashflow lender relies upon forecasts and projections, a challenging proposition in the current environment. However, the ABL lender is focussed on the here and now, tracking flows of money and goods to ensure that it constantly has an accurate view of the value of its collateral, the ease with which it can access and realise that collateral and the extent of any competing claims on the collateral. Even in these uncertain times, a diligent financier can build a very clear and accurate picture of what assets there are, where they are and how much they are worth, right now.
Collateral analysis is undertaken on a company by company basis, even in a group based financing. This is because, typically, enforcement of security and liquidation operates on a company by company basis. It is therefore important for an ABL lender to understand if there are any circumstances in which one of its collateral providers might assume liability as a result of the activities of another group company. There are a couple of well-known sleepers created by the Australian legislative regime. The ASIC class order guarantee regime and consolidated tax grouping each create scope for the liabilities of one group company to be visited upon another. However, these liabilities are generally well understood and, importantly, are unsecured.
Recent changes to the Corporations Act have introduced another, slightly more insidious, avenue for assuming liabilities. The Corporations Amendment (Strengthening Protections for Employee Entitlements) Act 2019 introduced provisions to the Corporations Act[1] allowing a court to issue an Employee Entitlement Contribution Order (EECO) in certain circumstances, in particular where one group member has received the benefit of the work of employees of other group members which exceeds the benefit that would be reasonable if the two entities were dealing at arm's length. EECO's are particularly concerning, because they may be afforded the same priority against the collateral provider as the relevant employee entitlements would have had against the employer company.
In the context of an ABL transaction, the collateral provider may be required to make a contribution to fund employee entitlements in the liquidation of a group employment vehicle where it has benefitted from the work done by those employees and benefit received exceeds the consideration it has already provided. The claim under the contribution order would rank above the ABL lender's claim in any collateral that is a circulating asset.
Thorough due diligence is a central component of structuring any ABL transaction. The introduction of EECO's means that the due diligence must inform a proper understanding of group employment arrangements, the extent to which collateral providers are benefitting from the work of employees of other group entities and what consideration the collateral providers have given in exchange for that work. That diligence work should be supported by ongoing reporting on intra-group employment arrangements and restrictive covenants that ensure that collateral providers cannot be exposed to a potentially significant EECO being awarded against them.
ABL lenders should check their diligence checklists to ensure this is covered and appropriate reserving is put in place to address potential EECO exposure. Potential ABL borrowers should be ready for an examination of their internal employee cost allocation and should ensure that these costs are properly allocated and provided for among the group on an arms' length basis.
[1]Section 588ZA
