Pick me first? Claimant for unpaid salary not a priority creditor
Schmitt v Carter [2014] FCA 1370 (15 December 2014)
WHAT YOU NEED TO KNOW
- The Federal Court of Australia recently confirmed that damages for early termination of a fixed term contract could not be considered a "retrenchment payment" attracting priority under s 556(1)(h) of the Corporations Act 2001 (Cth). The decision will be welcomed by secured creditors.
WHAT YOU NEED TO DO
- Be careful when determining the priority status of employee entitlements in the administration or liquidation process – the Court distinguishes between payments due under an employment contract, and those which only arise by way of compensation, because the contract is terminated. Contractual termination claims will still be provable against insolvent companies. However they will not enjoy priority status.
The Federal Court of Australia recently confirmed that a claim for "unpaid salary" that is, damages payable for dismissing an employee early in breach of a fixed term contract, could not be considered a "retrenchment payment" under s 556(1)(h) of the Corporations Act 2001 (Cth) (the Corporations Act), the priority creditor rules.
The decision
In Schmitt v Carter [2014] FCA 1370, Mr Schmitt was employed as the chief financial officer and company secretary of CMA Corporation Ltd (CMA) between May 2008 and December 2012. Between August 2010 and December 2012 he was a director of CMA. From February 2012, Mr Schmitt was employed on a fixed term contract, which was to continue until January 2015.
His employment was terminated summarily in December 2012. Solicitors for Mr Schmitt lodged two proofs of debt with CMA. The claim for leave entitlements was not in issue. The claim for "unpaid salary" was for salary for the unexpired balance of Mr Schmitt's fixed term contract, equivalent to $995,973.10.
CMA and its subsidiaries had executed a deed of company arrangement which classified past and present employees as "Class B Creditors" who would be entitled to receive their employee entitlements in priority to all other creditors, as stipulated under the Corporations Act priority creditor rules. Mr Schmitt argued that the amount he was claiming constituted a "retrenchment payment" for the purposes of s 556(1)(h) of the Corporations Act. Mr Schmitt appealed to the Federal Court of Australia against CMA's rejection of his proof.
In this appeal, Justice Gleeson determined that the claim could not be described as an amount payable "by virtue of" Mr Schmitt's employment contract, in accordance with the definition of retrenchment payment in s 556(2) of the Corporations Act, because Mr Schmitt's claim arose only upon termination of his contract. It was a claim for the loss of bargain resulting from CMA's breach of the contract. The amount for damages was to be calculated by reference to the position that would have arisen if the contract had been performed, the contract having been discharged. On this basis, his claim could not be considered a retrenchment payment.
Insolvency practitioners frequently terminate contracts of employment. Where the contract of employment or industrial instrument provides for a redundancy payment then priority status will be attributed to the claim under the s 556 priority regime. However, a claim purely for damages arising from the contractual termination in absence of a redundancy entitlement will not enjoy priority. Merely an unsecured claim will exist.
The implications
Clarity on when a claim for payment receives priority
Justice Gleeson followed the longstanding authority of Justice Young in Irons v Merchant Capital Ltd (1994) 116 FLR 204, which established the proposition that damages for wrongful dismissal are not "amounts payable…by virtue of an industrial instrument".
A retrenchment payment "by virtue of" of an employment contract must be a right of an employee, under an industrial instrument or a contract which remains in force, to be paid money on redundancy or retrenchment. A claim for damages for breach of contract, by wrongful dismissal for example, recognises that the contract is at an end and that the damages are due as compensation for termination of the contract.
The decision will further assist liquidators and administrators in deciding how to treat claims by current or former employees for unpaid employee entitlements in either liquidation or administration.
The decision will also provide receivers and secured creditors with further clarity in respect of which employee claims for unpaid entitlements will have priority over the claims of secured lenders with regard to circulating assets under section 561 of the Corporations Act.
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