After Killarnee: Another look at the Corporations Act priority regime

Background

The Supreme Court of New South Wales recently had cause to give consideration to the Full Federal Court’s decision in Killarnee.[1] The question before the Court in the matter of O’Keeffe Heneghan Pty Ltd (in liquidation); Aus Life Pty Ltd (in liquidation) and Rocky Neill Construction Pty Ltd (in liquidation) (KNF Construction)[2] was whether the priorities prescribed by sections 433, 556 and 561 of the Corporations Act 2001 (Cth) (the Act) applied to the payment of debts or claims in the winding up of companies trading together as partners of a partnership, whether by reason of:

a)     the Act applying to that effect; or

b)     because equity follows the law, following observations made in Killarnee.

The matter was adjourned because arguments were advanced which were dependent on the outcome of the decision in Killarnee. However, following the handing down of that decision, in November 2018, judgment in KNF Construction was delivered.

Facts

Three separate companies were incorporated for the purpose of entering into the KNF Construction Partnership Agreement, by which those entities recorded the terms on which they agreed to carry out the business of construction work and electrical and labour hire under the name KNF Construction, as a partnership.

The partnership conducted itself as just that. It lodged its accounts and paid tax as a partnership. It also entered into contractual relations as a partnership, including a finance facility and a general security agreement with IFG.

After time, the partnership companies each appointed voluntary administrators. Soon thereafter, IFG appointed receivers and managers to all present and after-acquired property of KNF Group, being the partnership. The partnership entered into liquidation and its employees were paid $448,939 through the Commonwealth Fair Entitlements Guarantee (FEG) Scheme.

Due to the existence of conflicting legal authority on the point, a question then arose as to how to apply any assets of the partnership. As such, the receivers brought proceedings seeking a declaration that the priority regime prescribed by sections 433, 556 and 560 of the Act does not apply to the payment of debts and liabilities of the partnership from the partnership assets. The Commonwealth took the opposing position.

The legislative position

After considering the conflicting authorities, the Court found that:

1.     Section 433 of the Act did not apply, since the receivers were appointed subsequent to the companies entering into liquidation, section 433(2)(b) excluding the application of that section where, at the date of the appointment of a receiver to a company, the company had commenced to be wound up voluntarily.

2.     Sections 556 and 561 also did not apply, because the winding up of the partnership should occur in accordance with the Partnership Act 1892 (NSW). Section 561 provides that, so far as property of a company available for payment of creditors other than secured creditors is insufficient to make payment of, relevantly, any debt referred to in paragraph 556(1)(e), (g) or (h), payment of that debt or amount must be made in priority over the claims of the secured party in relation to a circulating interest created by the company. In Black J’s view, nothing in those sections function to supplant sections 39 and 44 of the Partnership Act, which deal with the application of partnership property on dissolution of the partnership. Black J’s view was reinforced by the fact that the application of section 561 depends on the amount of the debts referred to in sections 556(1)(e), (g) and (h), and the amount of those debts must be determined for a particular company, rather than collectively for the several companies that are companies in a partnership.

Equity

The Court also found that equity did not follow the law so as to apply the Act’s priority regime to a partnership in these circumstances. The Commonwealth argued that it should, consistent with the approach (it was contended was) taken in Killarnee and relying on the observation that “Where…a company in liquidation has been formed to operate as trustee of a trading trust to conduct a business which could (but for access to the capacity to income split or other taxation advantages) have equally plausibly have been conducted by the Company in its own right, it is difficult to see why the order of priority as prescribed in the priority regime under the Act should not be accorded to liquidators and employees under equitable principles.”[3]

Black J distinguished Killarnee on the basis that those observations were specifically directed to the position where a company conducts a business as a trustee of a trading trust that it could have conducted in its own right. They were not directed to the position of a partnership, where there are significant legal, structural and taxation differences between conducting a business in a company (with limited liability) and in an unincorporated partnership. Moreover, the Commonwealth made no compelling submissions as to why, so far as equity follows the Act, that should require it to apply the order of priority set out in section 561 where that order is not applicable by the statute. There is simply no consistent statutory approach to be followed.

Conclusion

This decision has provided welcome clarity on a previous legal ‘grey area’. For now, corporate partners of a firm can at least obtain some assurance (more than previously existed) that assets of the partnership will not be captured by the priority regime set out in the Corporations Act, and need only consider the relevant provisions of the Partnership Act upon any dissolution.

[1] Killarnee Civil & Concrete Contractors Pty Ltd (ACN 085 230 486 (in liq)) v Matrix Partners Pty Ltd (2018) 354 ALR 436

[2] In the matter of O’Keeffe Heneghan Pty Ltd (in liquidation); Aus Life Pty Ltd (in liquidation); And in the matter of: O’Keeffe Heneghan Pty Ltd (in liquidation) and Rocky Neill Construction Pty Ltd (in liquidation) trading as KNF Group (a firm) [2018] NSWSC 1885

[3] Killarnee Civil & Concrete Contractors Pty Ltd (ACN 085 230 486 (in liq)) v Matrix Partners Pty Ltd (2018) 354 ALR 436, at [222]