DETERMINING SECONDARY LIABILITY: IN SEARCH OF LEGISLATIVE COHERENCE.

• Date: 01 August 2019
• Author: Anderson, Helen

Contents I Introduction II Policy Objectives and Variables A Policy Objectives B Variables III Examples of Secondary Liability A Direct Liability for Unpaid Company Debts 1 Director Penalty Notices 2 Insolvent Trading Liability 3 Combating Illegal Phoenixing Bill 4 Protecting Employee Entitlements 5 Discussion B Accessory Liability C Multi-Company Arrangements 1 Insolvent Trading Liability of Holding Companies 2 Pooling 3 Protecting Vulnerable Workers Act 4 State Payroll Tax 5 Strengthening Protections Act 6 Discussion IV Coherence V Analysis A Important Variables and Present Inconsistencies 1 Formal Status of the Outside Party to Be Held Liable 2 The Identity of the Enforcer and Their Methods 3 Treatment of Accessories 4 The Tests of Liability B How to Achieve Coherence with Secondary Liability VI Conclusion I Introduction

Australia is arguably in the midst of a legislative boom to improve recovery for creditors. There are two related motivations for the recent action. The first is a perennial issue with companies: as a separate legal entity, a limited liability company can be liquidated leaving creditors unpaid, without its shareholders bearing the financial burden of its debts. (1) The second is the apparently increasing use of corporate structures and intercorporate contracting to facilitate transactions that leave creditors, in particular employees and the government, exposed to considerable financial loss. Imposing secondary liability, where someone involved in some way in the company's undesirable behaviour can be made to recompense those losses, becomes an attractive proposition.

Recent years have seen a spate of enacted and drafted provisions that seek to impose liability on one party where there has been a default by another. In 2017, provisions were inserted into the Fair Work Act 2009 (Cth) ('Fair Work Act') to assist the workers of franchisees and subsidiary companies by imposing liability for their entitlements on responsible franchisors and holding companies. (2) In April 2019, legislation was enacted to amend the Corporations Act 2001 (Cth) ('Corporations Act') to allow contribution orders to protect employee entitlements. (3) It followed a consultation paper dealing with corporate misuse of the Fair Entitlements Guarantee ('FEG'). (4) The consultation paper explored options to address 'sharp corporate practices', such as 'utilising a corporate structure ... in ways that the employees are employed by an entity which does not appropriately provide for their employee entitlements'. (5) There was also consultation about amendments to the Corporations Act designed to combat illegal phoenix activity by imposing liability on officers and others with respect to creditor-defeating dispositions. (6) Dealing with non-compliance from another angle, federal Parliament has also passed laws to significantly overhaul and increase Corporations Act penalties. (7) However, for reasons that are not explained in accompanying material, the formats of these three reforms differ noticeably from each other and from earlier pieces of legislation imposing secondary liability, creating what could be described as a 'wilderness of single instances'. (8) This paper stands back from the current legislative activity and questions the approach being taken by the federal government. It leaves aside the issue of whether new laws are presently needed, or whether current laws imposing liability on primary wrongdoers are simply underenforced. It proceeds on the basis that the government has embarked upon a legislative program of imposing secondary liability as a solution to some of its present problems, and seeks to shed light on the best way to approach it.

Where there is a desire to prevent the corporate form from being abused, the practical solution may involve legislating for ex ante means of disrupting or discouraging the behaviour. The payment of a security bond by a company against the possibility that it may default on its tax obligations may achieve this. (9) Another form of ex ante disruption is labour hire licensing, to overcome the creation of labour hire companies by unscrupulous people leading to underpayment or non-payment of employee entitlements. (10) These means of thwarting non-payment are excluded from this discussion.

Despite these and other ways of dealing with creditor losses, there is a legitimate case to be made for imposing secondary liability where the company that is primarily liable defaults. Not all corporate failures are deliberate, and it is not appropriate to seek recovery from a party other than the company as a matter of course. Nonetheless, secondary liability removes the financial incentive towards 'remote' wrongdoing, where the primarily liable party was set up to fail so that some other party can gain. In consequence, it achieves a more level playing field in the marketplace, and it helps to protect the revenue of other vulnerable parties such as employees. Substance could be said to triumph over form. Secondary liability that imposes a genuine burden--for example, payment of another entity's wages or tax obligations--has the benefit of overcoming the 'cost of doing business' view of a small penalty through accessory liability.

There are those that dispute the view that corporate entities respond to incentives, including economic incentives such as secondary liability, to act legally and responsibly. (11) At the same time, it is important to recognise the legitimacy of allowing businesses to structure their corporate affairs across multiple related companies or economic groupings and through contractual arrangements. Not all creditors are equally vulnerable and in need of additional recovery mechanisms. (12) Governments are most unlikely to want to challenge the separate legal entity status of limited liability companies in any fundamental way. In addition, the present Coalition government has articulated a need to encourage innovation, and not penalise legitimate failure. (13) A proper balance is needed between liability imposition and the legitimate protection of shareholders and other corporate outsiders. Where, then, to draw the liability line?

Part II looks at the policy objectives underpinning legislation in the current context and the variables that make up secondary liability provisions. These objectives and variables are displayed in Part III, which investigates a variety of situations where secondary liability may be attributed to a party other than the primary debtor or wrongdoer. For want of a better title, this individual or company will be referred to as the 'outside party'. Part IV considers coherence from the practical perspective: what it means, and what it can contribute to law reform in the present context. It argues for a coherent, principled approach to imposing secondary liability across the spectrum of relevant legislation. If the law is to treat a similar situation in a different way, there should be a reason for it. Part V provides the analysis, teasing out the principled bases upon which secondary liability for unpaid corporate debts might best be legislated, and exploring how in practice this might be achieved. Part VI concludes that where there is perceived to be a need for new laws imposing secondary liability to overcome sharp corporate practices, those provisions should be developed in a principled and coherent manner.

II Policy Objectives and Variables

For the purpose of the present discussion, there are two relevant dimensions to legislation: what it is trying to achieve, and how it goes about it.

A Policy Objectives

Some of the policy objectives of a government are stated in explanatory memoranda or media releases accompanying an exposure draft. In the current context, these objectives typically will include things like protecting the government's revenue, the entitlements of employees, or the rights of creditors generally. (14) Other aspects are often noted, such as the need to deter wrongdoing and provide a remedy for those who suffer financial loss. (15) Economic factors may be mentioned, such as the 'aim to promote a culture of entrepreneurship and innovation which will help drive business growth, local jobs and global success'. (16) These policy objectives may influence the way in which the legislation is interpreted. (17)

Even so, there are likely to be unstated policy objectives that underpin legislation. To the extent possible, governments are likely to want breaches that can be readily detected, and laws that are enforceable effectively and efficiently. Legislation needs to be balanced so that there is not significant political opposition to it, nor an outcry from the media or lobby groups representing business, community groups, or employees. (18) Unintended collateral damage, such as an adverse effect on an innocent group of people or to the economy as a whole, should be avoided.

A further set of objectives also exist, based on political, rather than policy, imperatives. In the name of 'signalling', legislation is sometimes passed principally to 'send a message' to a group of identified wrongdoers. It is possible that existing legislation is already sufficient to capture their activities but it is either underenforced or inadequate, such that the wrongdoing continues. The government of the day may want to be seen to be acting, perhaps to deflect political criticism, and introducing legislation is one of the cheapest and most public ways of achieving that. Once drafted, this sort of legislation may suffer from being too descriptive of a certain scenario, and in doing so, provides a convenient roadmap to avoidance. Or it may be a draconian criminal provision that manages to be completely unenforceable. Examples of these situations are provided in Part III.

B Variables

Legislation comprises a set of variables, best illustrated in the present context by asking a series of related questions. Who is to be held liable and on what basis? Is...