So you think employees get a preference do you?
It is reasonably well understood by professional advisers that when a company is placed into liquidation, employees of that company are afforded a certain level of preference for amounts owed to them when it comes time to divvy up the funds realised by a liquidator. However, when it comes time to work out who gets what, an employee may feel less than pleased with the outcome.
Schedule Seven of the Companies Act 1993 sets out the preferences that must be followed by a liquidator when distributing available funds to creditors. With the exception of certain secured creditors and assets, amounts owed to employees for salary and wages, unpaid holiday pay and redundancy are given preference over other amounts owed, including debts due to the Inland Revenue Department and unsecured creditors.
However, there are some restrictions and limitations which may affect an employee’s preference.
Time and Money
An employee’s preferential status under the Schedule is limited from both a time period and quantum perspective.
An employee preference for unpaid wages and salaries is limited to that amount earned in the four month period leading up to the date of liquidation. In addition, the total claim of any single employee which is treated as preferential (which may include unpaid wages, holiday pay due and possibly redundancy) is capped at $20,340 (an amount which may be altered from time to time by Order in Council). Any unpaid wages and salaries older than four months or any amount of an employee preferential claim that exceeds in total $20,340, will be an unsecured claim in the liquidation.
Working for the Family Firm
The schedule seven definition of employee, to which preferential status is afforded, excludes any person who was at the time of liquidation (or the 12 months leading up to liquidation) a director of the company in liquidation, or a nominee or relative of, or a trustee for, a director of the company.
This definition of employee can have a significant impact on certain employees of a company, for example where a relative of a company director is employed (which given the large number of family owned and operated businesses in New Zealand, is quite common). If you are related to a director you lose your preferential status under schedule seven.
Redundancy and Notice in Lieu
Schedule seven includes, as preferential (but subject to the maximum dollar limit) an employee’s entitlement to redundancy. What many employees do not realise is that entitlement to redundancy is not automatic and must be a specific part of their employment agreement. Further, the right to redundancy, and in what circumstances it may be payable under their employment agreement will have a bearing on whether or not it is treated as part of their preferential entitlement.
In our experience not many individual employment agreements have a redundancy provision, the common exception to this are cases where employees are part of a collective Union agreement in which specific redundancy provisions may be included.
Many employees assume that their entitlement to payment in lieu of notice should form part of their preferential entitlement. This however is not the case. Preferential entitlements are limited to unpaid wages and salary, holiday pay and redundancy (where applicable). Entitlement to payment in lieu of notice when terminated as a result of liquidation does not form part of this entitlement. Instead, an employee will be an unsecured creditor in a liquidation for any such amounts.
Use the company credit card
Employees can also find themselves falling out of the preferential bucket in relation to expense claims they may have which remain unpaid by the company at the time of liquidation. It will depend upon the specifics of the individual case, including the terms of their employment agreement, but employee expense claims would not ordinarily be considered wages and salary, and therefore would not typically form part of any employee’s preferential entitlements. This can leave an employee significantly out of pocket and joining the queue of unsecured creditors when they have been using their personal credit card to cover company expenses.
There are good policy reasons for having employees included as preferential creditors in liquidation. Unfortunately receiving preferential treatment is not always what it is seems.