Working out your priorities – how employee creditors claims were able to trump research and development tax refunds

In the recent case of In the matter of Spitfire Corporation Limited (in liquidation) and Aspirio Pty Ltd (in liquidation) [2022] NSWSC 340, the NSW Supreme Court has provided clarity on the order of priority for employee debts and secured creditor claims, where the key asset is an entitlement to tax refunds for research and development.

This matter involved the liquidators of Spitfire Corporation seeking directions under s 90-15 of the Insolvency Practice Schedule (Corporations) that:

• they would be justified in treating amounts received by Spitfire Corporation by way of research and development tax incentive refunds while it was under administration (R&D Refunds) as subject to a circulating security interest; and
• using the R&D Refunds to pay any debts or amounts falling within paragraphs (a) and (b) of s 561 of the Corporations Act 2001 (Cth) (Corporations Act) in priority to any claim of a secured creditor, Resilient Investment Group Pty Ltd (Resilient).

Following their appointment in August 2020, the Liquidators for Spitfire lodged income tax returns for the 2018/2019 and 2019/2020 financial years. The lodgement subsequently triggered R&D tax refunds in excess of $2 million, which ultimately became the most significant asset in the liquidation of Spitfire Corporation.

A dispute arose between the Spitfire Group Employees and Resilient (secured creditors) as to whether, as at the date of the Liquidators’ appointment as voluntary administrators of Spitfire Corporation, the R&D Refunds were an asset subject to a circulating security interest available for distribution in accordance with s 561 of the Corporations Act. The Commonwealth were joined as an interested party.

The Liquidators subsequently sought directions from the Court as to how the R&D Refunds ought to 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).

Importantly, if the Court was satisfied that the R&D Refunds constituted ‘circulating assets’ under the PPSA, s 561 of the Corporations Act would be engaged. Section 561 provides that where a company’s property is insufficient to discharge the debts owed to employees, property which is subject to a circulating security interest must be used to pay employee debts before paying secured creditors.

Whether the R&D Refunds were an asset available for distribution under s 561 of the Corporations Act

The term ‘circulating security interest’ is defined as a PPSA security interest that has attached to a ‘circulating asset’ within the meaning of the PPSA. A ‘circulating asset’ is defined in s 340 of the PPSA as personal property in which a grantor has granted a security interest to a secured party.

The question to be determined was whether the R&D Refunds fell within section 340(5)(a) of the PPSA, 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.

The term ‘account’ is defined in s 10 of the PPSA as a monetary obligation that arises from either disposing of property, or granting a right or providing services in the ordinary course of a business of granting rights or providing services of that kind.

R&D Refunds as personal property within the scope of the PPSA

After considering the authorities, Justice Black determined that the R&D Refunds were ‘property’ and ‘personal property’ for the purposes of s 340(1) of the PPSA.

Importantly, His Honour noted that the R&D Refunds were ‘more than a mere expectancy’, as Spitfire Corporation was obliged to bring the research and development offsets to account in calculating its assessable income, and did not have a free choice whether to claim or require the R&D Refunds to which it was entitled.

Further, His Honour noted the research and development was done prior to liquidation, and the fact that the tax returns needed to be lodged before the refunds could be converted to money did not deprive them of the right to be characterised as property.

R&D Refunds as a circulating asset

In determining whether the R&D Refunds were circulating assets under s340(1)(a) and s 340(5) of the PPSA, Justice Black found that the R&D Refunds fell within the category of ‘account’ because:

• the R&D Refunds constituted a ‘monetary obligation’, as the entitlement to the refund was an existing legal obligation on one party to pay an identifiable monetary sum to another on an ascertainable date; and
• the right to the R&D Refunds arose from the ordinary business activities of Spitfire Corporation before its external administration and was not affected by its later appointment of administrators and its subsequent winding up.

For those reasons, His Honour found that the R&D Refunds were circulating assets under s 340(1)(a) of the PPSA and in turn were ‘circulating security interests’ as defined in s 51C of the Corporations Act.

Therefore, under s 561 of the Corporations Act, the Liquidators were required to pay debts owed to employees in priority over Resilient’s claims, and it was permissible for those payments to be made out of the R&D Refunds.

Key takeaway

Start-up businesses often hold an R&D tax refund as its key asset. The Spitfire decision provides improved certainty for stakeholders (including employees) as to the priority of R&D tax refunds in the course of liquidation.

Firstly, this judgment provides clarity that R&D tax refunds comprise circulating assets for the purposes of section 561 of the Corporations Act. This is of significant benefit to employees of early-stage technology companies, such as Spitfire, who have very few assets and may run out of capital before their product or service can be commercially realised.

Secondly, although this decision is less positive for secured creditors, it allows them to better manage expectations regarding their position with respect to R&D tax refunds in the event of a company’s insolvency.

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Authored by:

Fiona Fewtrell, Solicitor