21

Priority Creditors and their Debts are Always Controversial and Need Justifications even for the Colonial Beneficiaries of

Australia, Malaysia and Singapore

School of Commerce Research Paper Series 00-2

ISSN: 1441-3906

Christopher F. Symes

Senior Lecturer

School of Commerce

Flinders University of South Australia


1. Introduction

Recently, there has been a call for effective, modern insolvency laws in Asia.[1] Statutory priorities in insolvency must be effective in any jurisdiction and, so, priority given to any group of creditors should be justified. The insolvency laws in Australia, Singapore and Malaysia have similar statutory powers and each country gives a statutory priority to specified debts. However, the subject of priority creditors is always controversial[2] and varies across the jurisdictions. Exploring the controversial subject is important in light of the need to justify the break from that fundamental principle of insolvency law – equal distribution for all.

This paper looks at priority creditors in the three jurisdictions and concludes that it is time for government review in Singapore and Malaysia and for more empirical investigation of these priorities. Furthermore, the paper argues for the retention of employee related priorities and administrative expenses and for the repeal of the tax priority which currently exists in Malaysia and Singapore.

2. Insolvency Law in Australia, Singapore and Malaysia

All three jurisdictions have traditionally based their insolvency laws on common law tradition. For all three, there is a tendency to borrow insolvency principles and models from the UK and the USA including the treatment of priority creditors..[3]

In Australia, there is a modern insolvency law which has seen continued updating and even ‘Americanisation’ in the last 10 years, predominantly as a result of the Harmer Report of 1988. The early Companies Acts, the Companies Code and the present Corporations Law have provided a statute based insolvency law which is ably supported by a developing case law. The Uniform Companies Act was developed indirectly from earlier English legislation but Australia has not followed the English development of having a separate Insolvency Act. The influence of UK insolvency law still exists in some areas but, for much of insolvency law, the Australian law relies on its own developed statute and case law.

Singapore has begun to develop a hybrid insolvency model of law designed to be more compatible with local cultural and economic conditions and national aspirations.[4] The Court system is efficient and experienced and the Singapore Companies Act incorporates insolvency law. The law is based on the Malaysian Companies Act of 1965 which was itself based on the Uniform Companies Act 1961 of Victoria, Australia.[5] As mentioned earlier, this Australian legislation had some origins in earlier English Legislation.

Malaysia’s insolvency laws are based on the pre 1986 UK Insolvency laws such as the Insolvency Act 1976 (UK) and Australian legislation such as the Uniform Companies Act 1961. In Malaysia, there is a strong creditor focus and the insolvency provisions in the Companies Act are regarded as a useful method of debt collection primarily due to the effectiveness of the threat of insolvency in that culture.[6]

3. The Three Jurisdictions Priority Creditors

The treatment of priority creditors in all three jurisdictions can be traced to the UK Companies Act of 1862 and the UK Preferential Payments on Bankruptcy Act 1888 (51 & 52 Vict. C.62 s.1). Each, though, have developed from the 19th century law to reflect changed economic climates and all were remarkably similar up until the early 1960’s.

Priority Creditors in Australia include the administration expenses of insolvency (including liquidations, provisional liquidations and receiverships) and employees’ wages and entitlements. Previous law gave priority to these two categories[7] and taxation debt. These included Pay As You Earn ‘PAYE’ (cost charges and expenses) tax instalments due to the company as employer, withholding tax [8], municipal or other local rates, certain taxes of the States and Territories (eg. payroll, land, repayment of development or mining grants), amounts due for goods supplied or services rendered by the States and Territories and, finally, amounts which a court had ordered the company to pay as reimbursement of expenses for a special investigation of the company’s affairs. Even earlier legislation allowed the Crown (in right of the Commonwealth) to claim priority for payment of any debts owing to it.

In Malaysia, priority creditors include the cost, charges and expenses of the insolvency, employees’ wages and entitlements and federal taxes, including goods and services tax. Few statutory changes have been recorded since the introduction of the Act in 1965.[9]

In Singapore, the priority creditors include the costs and expenses of the insolvency, employees’ wages and entitlements, taxation, and third party insurance claims.[10] Other legislation provides the banking and insurance sector, bank depositors[11] and insurance policyholders with priority.[12] The priorities section (s 328) was amended in 1984, 1987 and 1993.

4. Why have Preferential Debts ?

Statutory priorities given in insolvency are sometimes referred to as preferential debts, or as priority creditors, and the provisions are one of insolvency laws’ most critical and disputed areas. As the Cork Report observed in the UK:

“It is a fundamental objective … to achieve a rateable, that is to say, pari passu distribution of the uncharged assets of the insolvent among the unsecured creditors. In practice, however, this objective is seldom, if ever, attained. In the overwhelming majority of cases, it is substantially frustrated by the existence of preferential debts. These are unsecured debts which, by force of statute, fall to be paid in … winding up in priority to all other unsecured debts”.[13]

This continues to be in the case in most common law countries. It is helpful to explore the varied approaches to deal with the critical and disputed provisions.

The UK’s Cork Committee received a considerable volume of evidence, most of it critical of the present law, and much of it deeply hostile to the retention of any system of preferential debt.[14] This Report was conducted in 1982 upon the UK legislation which Singapore and Malaysia still closely adhere to. Yet, the Report recommended the abolition of preferential debts for rates, income tax, corporation tax, capital gains tax, and development law tax in the United Kingdom.[15] The reviewing Committee were left in no doubt that the elaborate system of priorities accorded by the present law was the cause of “much public dissatisfaction”, and that there was a widespread demand for a significant reduction or “even complete elimination” of the categories of debts which were accorded priority in an insolvency.[16] The Cork Committee used a model to achieve justification by reference to principles of fairness and equity that were likely to command general public acceptance.[17]

As the Cork Committee saw that it was their duty to re-examine the present categories of preferential debts with a view to retaining, curtailing or abolishing those that could not be justified, it is now the task of insolvency law reformers in Singapore and Malaysia to do the same. This is not to satisfy some imperialistic fervour but has worked impressively to review and justify priority creditors in both Australia and New Zealand. Australia reviewed its preferential debts with a view to justifying any that remained in Chapter 15 of the Harmer Report entitled ‘Priority Among Creditors’. In 1999, the New Zealand Law Commission produced a report for the Ministry of Commerce entitled “Priority Debts in the Distribution of Insolvent Estates”.

Garrido suggests that any insolvency law that discriminates amongst creditors must be revised and evaluated and criterion should be developed to determine priorities restrictively.[18] As observed, all of these jurisdictions ‘discriminate’ by having statutory defined priority creditors, yet there is little or no signs of Malaysia or Singapore undertaking revision, perhaps because the governments belive their approach to priority creditors is justified and correct.

Heath has also debated the position of priority creditors and suggested that, unless their preferential treatment can be justified by some social, economic or political reason, then priority must be abolished.[19] Each of the priorities in each of these three jurisdictions can also be investigated for social, economic and political justifications. This paper merely touches the surface of such an investigation.

In Canada, the Colter Report evaluated priority creditors in that jurisdiction and questioned the need of priority creditors to have the protection afforded by their priority.[20] The Report recommended and facilitated the removal of the tax priority. Also in Canada, Professor Ziegel examined the subordination of security rights in favour of priority creditors. He found support for an employees’ priority and, while not discounting other priority creditors, he favoured the use of other “probably more efficient methods” rather than subordinating the position of the secured creditor by legislation.[21] Some alternatives, such as social insurance, were suggested.

In Australia, the Harmer Report considered statutory priorities and acknowledged any departure from pari passu should be countenanced if justified by clearly defined principles and policy and, then, only when they enjoy general community support.[22] This Report suggested Australia move to its current position of two broad categories of priority creditors, namely administrative expenses and employees.

A revision of priority creditors may also help to achieve a better understanding of the purposes of insolvency, particularly in Malaysia. It appears that such broadening is required to change the perception that ‘the purpose of the law is to realise as many assets as possible and a bit of preference to employees’. [23]

5. Administration Expenses as a Preferential Debt

In all three jurisdictions, the cost, charges and expenses of winding up appear first in the order of priority for payment. This preferential debt is said to cover any expenses which the liquidator might be compelled to pay in respect of his/her acts in the course of a proper liquidation of the company’s assets.

In Australia, this priority includes the applicant’s taxed costs, the liquidation’s remuneration, the cost of any audit, long service leave and other leave entitlements and retrenchment amounts owing to an employee whose employment has been continued by the liquidator. It also includes the debts and liabilities incurred during the winding up and, if the liquidator carried on the business, these would include expenses such as salaries and wages of employees, rent, rates and even taxation (if there are profits earned during the liquidator’s control).[24] Street J (as he then was) suggested that “[T]here is no purpose in attempting to enumerate exhaustively the heads of expenses which will fall within this (priority). They must, however, be capable of being seen to relate to the winding up in the sense of being costs or expenses accruing in the course of the winding up. Rent is a classic instance.”[25]

The costs and expenses of recovering, preserving and realising the property of the company or carrying on its business, enjoy the first ranking because all creditors have an interest in maximising the amount available for distribution. This is also true of the costs of the application for the winding-up orders because it has initiated the liquidation.

The Harmer Report suggested this ranking and put, as its rationale for the Administration priority, that creditors have a community of interest in having a common agent to maximise a fund for distribution. Therefore, this ‘agent’ should enjoy their right to remuneration and an indemnity for expenses. The fairness of this priority was supported by the High Court in re. Universal Distributing Co. Ltd (in liqu) some 60 years ago.[26] To justify this ranking, it can be observed that the liquidator incurs the expenses without the benefit of an indemnity from creditors or the company and nor will the applicant have any indemnity beyond the priority.[27]

The priority also addresses the various expenses which are necessary for an orderly winding up. These include debts for which an administrator is entitled to be included under s443D(a), cost and expenses of the liquidator’s report as to the company’s affairs and the costs of an audit of the liquidator’s accounts.[28] The Harmer Committee was convinced that these costs were appropriate and should be paid before the remuneration of the liquidator.[29] Justification spans the social, economic and political reasoning.

The priority, of course, gives priority to remuneration or fees for service of the liquidator but this ranks behind the liquidation costs. It has been observed that administration costs are not strictly speaking preferential debts because they are not debts which would otherwise have been payable by the insolvent company pari passu with other creditors.[30] The reasoning runs that these costs would not have been incurred by the company had it been continuing as a solvent company and not winding up or under some other form of external administration. However, Heath justifies the costs by arguing there is a public interest in ensuring liquidation are administered professionally and competently and, without the guarantee of costs being recovered, it would be difficult to encourage qualified people to take on the position.[31]

The Cork Report received many submissions suggesting that the costs of administering an insolvent estate were excessive and that the insolvency professionals received “an unreasonable proportion of the total assets, leaving insufficient for the creditors”. The Cork Committee defended this position stating that they could understand the “grievance felt by a creditor who receives a statement showing (as sometimes happens) more than half of the trustee’s (insolvency professional’s) receipts being applied to the expenses of the administration” but that it “must be borne in mind that the degree of skill and attention and the amount of work required by a particular insolvency is not necessarily related to the amount ultimately recovered.”[32] This summarises the situation in most Western jurisdictions and, in part, justifies the priority. The cynic would see that civil and criminal litigation often have a similar unsatisfactory result for the aggrieved party and, so, we have come to not expect the amount recovered to bear any relationship with the cost of doing the recovery.

What must be kept in mind is that in addition to the statutory priority there is also an equitable lien outside of the statutory priority for the expenses, remuneration and costs of a receiver[33], provisional liquidation[34], and liquidator[35], over any assets which she/he brought to the court for distribution.