Subrogation occurs when a person or a creditor agrees to pay creditors of the insolvent company in consideration for the right to subrogate into the position of that creditor.

An example of subrogation in insolvency is, when a creditor (typically, a related party) elects to pay employee entitlements owed by the company in consideration for the right to subrogate into the priority position of the employees.  This is permitted pursuant to Section 560 of the Corporations Act 2001.  The Attorney-General’s Department also applies this section of the Act once it has approved and paid former employees their entitlements.  The Department then stands in the shoes of the former employees as a subrogated creditor and is entitled to claim in the liquidation as a priority creditor.  This issue was also discussed in The Dalma Case.

One of the common issues dealt with in relation to the issue of subrogation is when does subrogation actually occur?

WAS THERE A SUBROGATION?

Subrogation generally takes place under the two following circumstances:

• Where a guarantor pays out all of the debt of the insolvent company which it has guaranteed; and
• Where a creditor pays off the secured debts of an insolvent company.

A guarantor is able to take the place of the lender and makes a claim against the company once payment of the secured debt has been settled in full.  The guarantor is also entitled to whatever security the lender held including its place as a secured party in the external administration.  This happens by operation of law and needs no separate agreement to be effective.  Subrogation clauses however are generally included in Personal Guarantee Agreements. However quite often, a third party who is a non-guarantor, pays a debt on behalf of the company on the assumption that by doing so automatically qualifies them to claim against the company.  In this case, and in absence of any suitable agreement to confirm otherwise, this does not provide an automatic right of subrogation. 

Subrogation should not be assumed to have taken place if the debt is not paid as a guarantor.  To mitigate this and to ensure the chance of subrogation being acknowledged, the third-party payor should obtain a properly prepared and executed assignment of the claim from the company at the time of payment. Another instance where subrogation is regarded to have taken place is when the debt of a secured creditor has been paid out by a third party.  This is mainly to allow the third party to put itself in the position of the secured creditor and assume all of its rights, benefits and entitlements.  This is undertaken for a host of reasons potentially when an AllPap security is held as it generally provides the party with a priority over unsecured creditor claims.

RELATED PARTIES AND VOTING USING SUBROGATED CLAIMS

Can a creditor vote and prove a claim in an external administration, for a debt that is taken over from another creditor?  This question frequently arises during the adjudication of claims for voting and dividend purposes.  The admissibility of such a claim will depend on the circumstances under which the payment was made – of which the occurrences have been discussed above.

Have a think of this scenario – a related party of the insolvent company spontaneously pays the unsecured debts of various creditors without any request by the company for that payment to be made.  Should the third party be allowed to have a claim against the company and be entitled to vote at a creditors’ meeting?

Reference can be drawn relevantly from the Dalma Case, in which Justice Brereton held:

At [33]: While the common law restitutionary claim for moneys paid might avail a third party who discharges a debt at the express or implied request of the debtor, its availability is contingent on an express or implied request; there is no such remedy for a third party who spontaneously pays off a debtor’s unsecured liability.

At [37]: In my view, the only context in which a spontaneous voluntary payment by a third party may found a claim for subrogation is in the exceptional category of the payment off of existing securities. There is no authority for extending that exceptional case to unsecured debts.

Therefore, the claims of a related party should not be admitted for voting purposes unless the claims satisfy what constitutes a subrogated claim.  It also bears little sense as to why the related party would pay off the unsecured debts as, unlike secured debts, holds little benefit and would result in little chance of recovery.  One can only assume that this was done for the purpose of ‘vote-stacking’. To expand on the above, the ILRA has also imposed restrictions on voting rights of related party creditors under the Insolvency Practice Rules (Corp) 2016, in particular, under IPR 75-95 and IPR 75-110.

By Bernie Lim