- Employees have priority over other unsecured creditors in the case of insolvency, though the exact priority depends on the employee entitlement in question;
- The Fair Entitlements Guarantee (FEG) Scheme is intended to be a scheme of last resort, however, it appears to be misused by some companies that are wound-up;
- Contractors are not employees and therefore do not have priority over other unsecured creditors in a liquidation and do not have access to the FEG scheme;
- Contractor remedies at the point of insolvency are extremely limited. In light of this, contractors need to consider the possibility of liquidation when initially entering into contracts.
Estimated reading time: 6 minutes
In most cases, the winding up of a company ends a person’s employment. What does that mean if that person is owed money or entitlements? If that person is not an employee, but rather, a contractor, what are their entitlements? In this article we set out to answer those questions. We consider:
- The priority of claims in liquidation;
- The FEG Scheme;
- The difference between an employee and a contractor;
- Options available for contractors to respond to a winding up.
The priority of employees and their entitlements in liquidation
When a company is wound up, secured creditors are paid first. After that, all unsecured creditors are paid in accordance with priority rules set out in section 556 of the Corporations Act 2001. First in priority are costs related to liquidation and administration. This includes liquidator (and other administrator) fees and expenses, the costs of a court-ordered winding up and costs related to a committee of inspection. Next in priority are employee entitlements. The priority of employee entitlements are:
- wages, superannuation contributions and superannuation guarantee charge payable by the company to employees at the time of or immediately prior to the winding up;
- liabilities relating to the superannuation guarantee charge;
- amounts due in respect of injury compensation;
- leave of absence entitlements which are set by an industrial instrument;
- retrenchment payments payable to employees of the company
After the paying of these entitlements, the remaining assets are to be distributed to remaining unsecured creditors who are to be treated equally in proportion to the size of their claim.
Fair Entitlements Guarantee (FEG) Scheme
The FEG Scheme, previously known as the General Employee Entitlements and Redundancy Scheme (GEERS) is available to all eligible employees to ensure they get (some) of what they are entitled to. The FEG Scheme provides for:
- Unpaid wages of up to 13 weeks (capped at a maximum weekly wage, currently set at $2,451);
- annual leave;
- long service leave;
- payment in lieu of notice of termination set at a maximum of 5 weeks;
- redundancy pay of up to 4 weeks per full year of service.
Note, that the FEG Scheme does not cover all employee entitlements. It does not cover:
- reimbursement payments;
- one-off or irregular payments;
- bonus payments;
- non-ongoing or irregular commissions.
For more information on the FEG Scheme see https://www.fairwork.gov.au/ending-employment/bankruptcy-and-liquidation.
The FEG scheme, as a scheme of last resort, is intended only to apply where there are insufficient assets to pay out employee entitlements. Note also that there are eligibility restrictions. The restrictions include the scheme not applying to contractors and those who have been directors of the company within the last 12 months of the company, among other conditions.
There has been concern in recent years that companies have been misusing the FEG Scheme, including the occurrence of ‘illegal phoenix activity’, where assets have been transferred out of the company prior to insolvency which would have otherwise been used to pay employees their entitlements. For more about this activity, see What is phoenix activity and how does the law (attempt to) regulate it?
Contractors are not employees
As contractors are not employees, they are simply ordinary unsecured creditors when it comes to the winding up of the company. This means that (a), they have no priority in liquidation and (b), they have no access to the FEG Scheme. This means that the following question becomes crucial: is a given individual an employee or a contractor? The answer does not depend simply, on whether there is an employment agreement or contract in place. There is no hard-and-fast rule determining whether a given person falls into one category or the other. However, for tax and superannuation purposes, the Australian Tax Office considers the following factors determinative:
- Ability to subcontract/delegate: An employee generally cannot subcontract/delegate their work, but a contractor can;
- Basis of payment. An employee is paid either for the time worked, a price per item or activity or a commission, whereas a contractor is paid for a result achieved;
- Equipment, tools and other assets. Employees are usually supplied equipment and tools whereas contractors usually supply their own;
- Commercial risks. The worker takes no commercial risks as the business is responsible for the work done and rectifying it. Contractors take commercial risks and are responsible for rectifying any defects in work completed;
- Control over the work. The business has the right to direct employees in how they get their work done, whereas a contractor has considerable freedom in how they complete the work;
- The worker is part of the business whereas the contractor operates an independent business and is free to accept or refuse additional work.
For further information see https://www.ato.gov.au/business/employee-or-contractor/difference-between-employees-and-contractors/.
Options for Contractors
As the majority of liquidations in Australia result in very few assets remaining to distribute to unsecured creditors, this will often mean unsecured creditors walk away from a liquidation empty-handed. In light of this, it is important that contractors take into account this commercial risk when they enter into a contract and frame their prices accordingly. In addition, it may be possible in some cases for contractors to secure their debts through registration of a security interest (e.g. over equipment of the debtor company).
Once winding up is under way, what options are open to the contractor to get what they are owed? Options for contractors are limited, but matters worth considering include:
- Making a claim of ‘sham contracting’. Considering the factors outlined in section three, ‘contractors’ might consider whether they are in fact employees and therefore entitled to priority in liquidation and/or access to the FEG Scheme.
- Using creditors’ remedies to increase the pool of remaining assets. An ‘unfair preference’ claim might be made where one creditor (such as a contractor) has been discriminated against in favour of another contractor. This can occur when the company has made payments to one creditor prior to winding up where the company was already insolvent.