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A liquidator's obligation to reject proofs of debt claiming entitlements based on unlawful employment contracts

On 3 July 2015 the Federal Court of Australia delivered its reasons in Re Perthmetro Pty Ltd (in liq) [2015] FCA 671. The decision confirms that liquidators should not admit proofs for unpaid employee entitlements if the relevant employment contracts are illegal, or otherwise unenforceable as a matter of public policy

Background

The liquidator of Perthmetro Pty Ltd (in liquidation) (“Company”) applied to the Federal Court of Australia pursuant to section 511(1)(a) of the Corporations Act 2001 (Cth) (“Act”) seeking directions as to whether any proofs of debt which one or more of certain former employees may lodge should be rejected on the basis that their respective employment contracts were tainted by illegality or were offensive to public policy.

The Company had agreed with its directors, David Hicks and Robert Pilkington, and their respective wives, Angela Hicks and Jackie Pilkington, that it would direct payment of part of the directors’ salaries to their wives in each case. Jackie Pilkington did work part time for the Company (which was separately accounted for) but Angela Hicks did not.

Neither wife performed work in return for the amounts paid, but rather received payments which in truth formed part of her respective husband’s income. The directors’ respective “incomes” under the arrangements were found to be approximately $30,000 less than their “true” incomes.

Decision of the Federal Court

After considering the authorities as to illegality of contracts, the Court found that:

  • it was satisfied that each of the four arrangements was structured with the knowledge and intent of all parties such as to avoid the payment of tax;
  • the arrangements in each case contemplated that salary payable to one person was directed to another and withholding tax was deducted as if the other person was entitled to that salary - this involved misrepresentations to the Commissioner for Taxation;
  • the schemes between the Company and the employees were offensive to the system to collect income tax in Australia; and
  • it was not disproportionate to find the arrangements unenforceable on the basis of the seriousness of the unlawful conduct.

The Court ordered that:

  • the liquidator was not to admit proofs of debt based on the claims for employee entitlements that may be lodged by David Hicks, Angela Hicks or Robert Pilkington at all or Jackie Pilkington (for any remuneration paid to her on behalf of her husband); and
  • the liquidator should admit a proof based on any claim for employee entitlements of Jackie Pilkington, other than as related to remuneration which was paid or was payable in truth to Robert Pilkington.

Conclusion

A liquidator should not admit a proof of debt claiming employee entitlements based on an employment contract which is illegal or unenforceable as a matter of public policy. This will include an arrangement to pay wages to a director’s family member who is not, in truth, an employee for the purpose of avoiding payment of tax.

Cowell Clarke has significant expertise and experience in corporate insolvency law and employment law. If you need any assistance concerning adjudication upon proofs of debt or have any insolvency related queries, do not hesitate to contact us.

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