Whizz… Bang! Employee creditors have priority to R&D tax refunds, and the “true employer” line of authorities upheld

The recent judgment of the New South Wales Supreme Court in Re Spitfire Corporation Limited (in liquidation) [2022] NSWSC 340 traverses a number of important and novel issues confronting liquidators, employees and secured creditors in relation to the (often limited) pool of assets of failed early stage technology start-up companies.

The decision considered Spitfire Corporation Ltd (in liq) and its subsidiaries (collectively, Spitfire Group), which conducted an online wealth management technology business. Like many technology start-up businesses, it drew on Commonwealth research and development (R&D) incentives (along with funding from seed capital investors and venture capital), to further its objective to ultimately commercialise the products and applications it developed. At the time of its collapse in 2020, attempts to raise further capital had been unsuccessful.

In the corporate structure adopted by the Spitfire Group, one entity (Aspirio Pty Ltd) served as the employer of record for almost all of the employees of the Spitfire Group. Importantly, Aspirio did not perform any other function or service, had no external clients and did not charge Spitfire Corporation (or any of the other companies in the Spitfire Group) any fee or other amount in connection with being the “employer entity” or providing employment related services to the Spitfire Group companies. Aspirio generated no revenue, operated at all times at a loss and had no assets of realisable value.

On 7 August 2020 (Appointment Date), liquidators Kate Barnet and Damien Hodgkinson were appointed as external administrators of Spitfire Corporation and most of the entities in the Spitfire Group (including Aspirio). Following their appointment, they attended to the lodgement of income tax returns (including R&D tax incentive applications) for the financial years ended on 30 June 2019 and 30 June 2020. The lodgement of those tax returns led to the receipt of R&D tax refunds from the ATO totalling $2,024,812.90 (R&D Refunds). The R&D Refunds constituted the most significant asset in the liquidation of Spitfire Corporation.

The Liquidators subsequently sought directions from the Court as to how the R&D Refunds ought be dealt with in the winding up. This involved asking the Court to determine:

• whether the R&D Refunds comprised a "circulating asset" within the meaning of section 340(1)(b) or s340(5)(a) of the Personal Property Securities Act 2009 (Cth) (PPSA); and
• which of Aspirio or Spitfire Corporation was the "true employer" of the Spitfire Group Employees.

At a commercial level, the resolution of those issues would determine whether the group's secured creditor (Resilient Investment Group Pty Ltd (Resilient)), or the Spitfire Group Employees would, pursuant to section 561 of the Corporations Act 2001 (Cth), have priority in respect of any dividend declared from the proceeds of the R&D Refunds. The Commonwealth, represented by the Attorney-General's Department, was subrogated to the rights of the Spitfire Group Employees to the extent it had paid advances to them pursuant to the Fair Entitlements Guarantee Act 2012 (Cth). Resilient and the Commonwealth were granted leave to appear and be heard on the Liquidators' application.

Clayton Utz's Restructuring and Insolvency team, along with Amber Agustin from our Tax team, acted for the Commonwealth on the application.

R&D Refunds are a circulating asset

The Court (Justice Black) found that the R&D Refunds satisfied the definition of "circulating asset" in section 340(5)(a) of the PPSA and therefore were an asset subject to a circulating security interest available for distribution in priority to priority employee creditors in accordance with section 561 of the Corporations Act.

Arriving at this conclusion required detailed analysis of the relevant taxation legislation.

The dispute ultimately boiled down to whether the R&D Refunds fell within section 340(5)(a) of the PPA, which applies to "an account that arises from granting a right, or providing services, in the ordinary course of a business of granting rights or providing services of that kind (whether or not the account debtor is the person to whom the right is granted or the services are provided)". The term "account" is defined in section 10 of the PPSA (in largely overlapping terms) as a "monetary obligation […] that arises from: (a) disposing of property […]; or (b) granting a right, or providing services, in the ordinary course of a business of granting rights or providing services of that kind (whether or not the account debtor is the person to whom the right is granted or the services are provided)".

The Court found that the R&D Refunds fell within the "account" category because:

• the R&D Refunds comprised a "monetary obligation", because Spitfire Corporation’s entitlement to the R&D Refund represented an existing legal right to an identifiable sum of money as at the Appointment Date; and
• the R&D Refunds arose from the provision of services in the ordinary course of a business of providing services of that kind. His Honour noted that the R&D activities that produced the R&D Refunds were undertaken for the "ultimate benefit of external customers of the Spitfire Group who used its products and services".

It followed that section 561 applied to the R&D Refunds with the consequence that the Liquidators were required to pay debts owed to employees pursuant to sections 556(1)(e), (g) and (h) in priority to Resilient's claims.

"True employer" analysis remains relevant

The NSW Supreme Court handed down an important judgment on the "true employer" issue in 2020 (see our note on that decision, here). The novel aspect of the "true employer" issue in the Spitfire application was a threshold issue as to the proper legal approach, following the recent decisions of the High Court of Australia in Personnel Contracting, ZG Operations and WorkPac. Resilient submitted that, following those decisions, determination of the “true employer” does not permit inquiry beyond the employment contract (other than in cases of sham or contractual variation). To the extent that earlier authorities in the context of Pt 5.6 Div 6 of the Corporations Act permitted reference to the “totality of the relationship” or to a “multifactorial analysis” (including the appellate decisions in Pitcher v Langford (1991) 23 NSWLR 142 and Shaw v Bindaree Beef Pty Ltd [2007] NSWCA 125, Resilient contended that those authorities had been overruled by the High Court, if not expressly, then impliedly.

Justice Black rejected that proposition. His Honour noted that the High Court decisions dealt with whether an employee was engaged on a casual or permanent basis (WorkPac) or whether a worker was an employee or an independent contractor (Personnel Contracting and ZG Operations), whereas the "true employer" cases are directed to ascertaining the identity of the party by whom a putative employee is engaged for the purposes of Pt 5.6 Div 6 of the Corporations Act .

In those circumstances, Justice Black found that he remained bound by the appellate decisions in Pitcher v Langford and Bindaree and the other first instance decisions in that line of authority. Applying those cases, and reasoning in a similar manner to his Honour's previous decision in Re Branded Media Holdings (noted above), Justice Black found that the true employer was Spitfire Corporation.