NEWS & INSIGHTS

Addressing Corporate Misuse of the FEG Scheme – Perspectives

The Australian Government’s Department of Employment and Workplace Relations (DEWR) has released a discussion paper titled "Addressing Corporate Misuse of the Fair Entitlements Guarantee", which explores reforms to curb the misuse of the FEG scheme.

This article considers some of the key issues raised in the discussion paper, shares our observations, and outlines the possible reforms to strengthen the integrity of the FEG scheme.

As industry participants, we’ve seen first hand how corporate structures and practices can lead to the suspected abuse of FEG, illegitimately shifting the cost of employee entitlements of insolvent businesses onto taxpayers.

What is the Fair Entitlements Guarantee (FEG)?

The FEG scheme is a government safety net that provides financial assistance to employees who lose their jobs due to their employer’s liquidation. FEG covers unpaid wages, annual leave, long service leave, payment in lieu of notice, and redundancy pay subject to certain eligibility criteria and DEWR’s discretion. However, FEG is intended as a last resort, meaning employees only turn to FEG when there are no other resources to meet their outstanding entitlements after their employing entity enters liquidation.

The DEWR discussion paper highlights concerns about the MISUSE OF FEG, particularly through the following “sharp corporate practices”:

1. Corporate Group Structures:

Businesses often operate through complex group structures, where employee liabilities are concentrated in an asset-poor entity, while assets are held in separate entities. When the employing entity becomes insolvent, the assets of the asset-rich entity are not available to staff and FEG steps in to cover employee entitlements, while the business continues trading through other entities in the group.

Our observation:

Such group structures are not uncommon and in particular it is commonplace for a group to have separate asset holding and operating entities. True employer test and the existing contribution order regime under section 588ZA are available to FEG to recover funds from asset-rich related entities in the group, though section 588ZA regime seems underused to date (The discussion paper noted that no application had been made under section 588ZA). More active use of the existing measures might provide a pathway to assessing the utility of the existing laws.

2. Illegal Phoenix Activity:

Illegal phoenix activity, where a company’s business is transferred (e.g. at undervalue) and the company is then liquidated, can result in the assets of the business being unavailable and the FEG scheme stepping in to meet employee entitlement claims.

Our observation:

In some instances, directors deliberately transfer assets from a company before liquidation, leaving employees reliant on FEG. We note that since the regulators, primarily, the Australian Taxation Office (ATO) and the Australian Securities & Investment Commission (ASIC), established the Phoenix Taskforce in 2014 to detect, deter and disrupt illegal phoenixing, we have seen increasing awareness of this illegal practice and employees and other stakeholders are more alert and active in reporting and assisting the IPs’ investigations into suspected illegal phoenix activities.

From February 2020, another voidable transaction claim, creditor-defeating disposition (section 588FDB) became available to liquidators. The legislation provides more power to the regulator (section 588FGAA), whereby ASIC may order the undoing of the effect of a creditor-defeating disposition. Part of officers’ duties is to prevent creditor-defeating dispositions (section 588GAB).

Directors should obtain advice when considering disposing of company’s assets when they suspect the company may be insolvent or the dispositions may result in insolvency of the company. We note that there has been some use of these measures to date, but enforcement is reliant on liquidators, ASIC and FEG, including funding of appropriate actions.

3. Misuse of Deeds of Company Arrangement (DOCAs):

In some cases, corporate groups use DOCAs to restructure asset-holding entities while leaving the employing entity in liquidation. This allows the business to continue trading without addressing employee entitlements, which are then covered by FEG.

Our observation:

DOCA must ensure employee entitlements have priority over other unsecured creditors unless eligible employees have agreed to vary their priority. Most DOCAs we have seen are designed to maintain the priority of employee entitlements as they would receive in a liquidation, or even carry the whole staff base onto the post-DOCA entity. However, this might not be the case for corporate groups and administrators and DOCA proponents should consider the existing legislation about group structures, true employer from Fair Work in formulating DOCA proposals.

4. Controllers Failing to Prioritise Employee Entitlements:

In some cases, controllers (e.g., receivers) appointed by secured creditors or other external administrators fail to properly account for circulating assets, which should be used to pay employee entitlements under sections 433 and 561 of the Corporations Act 2001. This can result in FEG meeting entitlements that are properly payable out of circulating asset recoveries.

Our observation:

The proper accounting for circulating and non-circulating assets rests firstly with the controller or external administrators appointed. The allocation of circulating and non-circulating recoveries and of costs as against circulating and non-circulating recoveries is not always straightforward and may present room for dispute. We have observed that FEG has become more active in liaising with external administrators regarding these matters and with a view to safeguarding recovery of funds by FEG.

"Wexted welcome's DEWR’s initiative to develop transparency around the nature of the abuses and applaud its efforts to improve the scheme."

Chris Johnson - Partner

The Impact of FEG Misuse

The misuse of FEG has significant consequences, including (among other things):

Increased Costs to Taxpayers: FEG expenditure is forecast to exceed $250 million annually until at least 2027-28, with a significant portion potentially attributable to corporate misuse.
Unfair Competitive Advantage: Businesses that avoid their obligations gain an unfair advantage over competitors who meet their employee entitlement obligations.
Employee Disadvantage: While FEG covers certain entitlements, subject to eligibility criteria and some capped amounts, it does not cover unpaid superannuation, leaving employees out of pocket. There are also often delays of six months or longer before funds become available to staff from FEG.

Possible Reforms

The DEWR discussion paper outlines several reform options:

Refining the Contribution Order Regime: Simplifying the evidentiary requirements and introducing rebuttable presumptions to make it easier for liquidators to seek contributions from related entities.
Joint and Several Liability Across Corporate Groups: Introducing joint and several liability for employee entitlements across corporate groups to ensure all entities in a group are responsible for employee obligations.
Reforming DOCAs: Requiring DOCAs to provide for employee entitlements of related entities in liquidation to prevent asset-holding entities from restructuring while leaving employee liabilities unpaid.
Strengthening Director Accountability: Refining the director disqualification provisions to make it easier to disqualify directors involved in FEG misuse.
Improving Access to Information: Giving priority unsecured creditors, including the Commonwealth, the right to request information from controllers to ensure compliance with their obligations to pay employee entitlements.
Including Superannuation Guarantee Charge (SGC) in FEG: Including SGC in the list of protected entitlements to provide greater protection for employees.

Wexted consider there is merit in all of these reasons as efforts to refine the FEG scheme continue.

Challenges and Considerations

Any reforms must be carefully considered to avoid unintended consequences, which could include:

Impact on Legitimate Restructuring: Reforms should not unduly hinder legitimate corporate restructuring or place excessive burdens on businesses.
Complexity of Contribution Orders: Even with simplified evidentiary requirements, proving benefit in contribution order cases may remain challenging. Clear guidance and case law will be essential.
Cost of Compliance: Any new requirements, such as increased information-sharing obligations, should be balanced against the costs imposed on controllers and liquidators.
Consideration of Broader Impacts: The implications of any proposed reforms should take into account the use of existing resources (and whether regulators are using those resources) as well as any broader impacts beyond the conduct targeted.

A Call for Balanced and Effective Reform

As insolvency practitioners, we see the impact of FEG misuse on employees, creditors, and taxpayers. While the FEG scheme plays a vital role in protecting employees, its integrity must be safeguarded. We welcome DEWR being proactive and open to a review of this kind, and permitting transparency around the nature of abuses. We consider that any reforms should be carefully calibrated.

The full discussion paper is available on the DEWR website. Stakeholders are encouraged to review the paper and consider submitting feedback on the proposed reforms by 31 March 2025. The consultation period is an opportunity to shape the future of FEG and ensure the reforms strike the right balance between protecting employees and supporting legitimate business practices.

Common Questions About FEG and Proposed Reforms

Q1: What is the Fair Entitlements Guarantee (FEG)?

FEG is a government scheme that provides financial assistance to employees who lose their jobs due to their employer’s insolvency. It covers unpaid wages, annual leave, long service leave, payment in lieu of notice, and redundancy pay, subject to certain eligibility criteria, capped amounts and DEWR’s discretion.

Q2: How significant is the misuse of FEG?

According to DEWR, in 2023-24, around 43% of FEG advances (approximately $90 million) were paid in cases where corporate group structures or suspected employee entitlement-defeating transactions were present. Additionally, 55% of large FEG cases (where advances exceeded $100,000) were identified as potentially involving avoidance of employee entitlements. This misuse not only burdens taxpayers but also disadvantages employees, creditors, and competitors.

Q3: What are the potential benefits of these reforms?

The reforms aim to:

Reduce the misuse of FEG by corporations, ensuring it remains a last-resort scheme.
Increase recoveries of FEG advances, reducing the burden on taxpayers.
Strengthen protections for employees, particularly in cases involving corporate group structures or illegal phoenix activity.
Promote greater transparency and accountability in insolvency processes.

Q4: How will these reforms impact insolvency practitioners?

Insolvency practitioners may face increased complexity in cases involving corporate group structures and new requirements for DOCAs. However, these reforms will also provide tools to address misuse and protect employee entitlements.