As a business owner are your personal assets really protected?
Operating a business has always been risky and the protection of personal assets is an important element in making a decision to go into business. I want to tell you Peter’s story. It should have been a good story; instead it’s a horror story, carrying a warning to all business operators that asset protection has become much more difficult.
Some years ago Peter was made redundant from a fairly senior position with a multinational company and received a healthy termination payment. While nearing retirement age, Peter was not ready to retire and used his termination payment to buy a business. The business was operated by a company with Peter as sole director and his wife, Jan, as sole shareholder. Peter worked hard; the business was quite successful and it supported the family comfortably for a number of years.
GOOD CONCLUSION
Six months ago Peter decided it was now
time to retire and Jan agreed it was a good
time to sell the business, given its history of
stability and profitability and the fact that there
seemed to be a lot of potential purchasers in
the market for good businesses.
A number of parties showed interest in the acquisition and, after negotiations, Jan accepted an offer for her shares. The sale was completed, and Peter was appointed by the new owner to remain with the business in a consulting capacity to facilitate a smooth transition. Peter and Jan popped the champagne, toasted their success, and paid out their mortgage. A good conclusion for a lifetime’s work.
But that’s not the end of the story. Prior to the sale of the business Peter, as sole director, had provided guarantees to some of the suppliers. Under the sale agreement he ceased to provide guarantees for purchases made after the sale and the company indemnified him from any claims made against him in respect of purchases prior to the sale. At the time of the sale the company was comfortably solvent and the debtors’ balances were more than sufficient to meet the liabilities to creditors.
A few weeks after the sale Peter began to suspect that the company’s liabilities were not being paid. His enquiries confirmed his suspicions and his employment with the company was terminated shortly after.
It was not long before creditors began to contact Peter personally and demand payment from him on the basis of his guarantees up to the date of sale. Peter was now in the same position as the creditors; his claims for indemnity from the company were worthless when the company no longer had any funds (for reasons unknown to Peter).
Peter was distressed but believed that the family assets would not be at risk. The sale proceeds belonged to Jan, as did his home which had been transferred to her before the business was acquired over six years earlier. In fact, Peter had no assets.
You would think that Jan’s assets would not be accessible to Peter’s creditors and perhaps at one time this would have been true.
However as a result of the High Court’s decision in Cummins case (The Trustee of the Property of John Daniel Cummins A Bankrupt v Cummins 2006) there is now, in basic terms, a merging of family law and bankruptcy law principles. As a result, where a spouse has made a contribution to an asset, such as the family home, they will be regarded as having an interest in the asset even where they are not the owner. This interest is taken to exist for bankruptcy law purposes as well as family law purposes, allowing a trustee in bankruptcy access to the asset to the extent of the bankrupt spouse’s interest. (I hope our insolvency practitioners forgive this inexpert summary of the position.)
In Peter’s case he had contributed to the mortgage payments on the home from his salary. This was sufficient to give the creditors a basis to claim a portion of the value of the home and sufficient to have Peter made bankrupt.
BITTER PILL
Instead of being able to sit back in retirement
Peter and Jan are now likely to have to sell
their home and start again, as creditors
claims are compounded by legal costs and
the whole disaster spirals into enormous
debt. This is a bitter pill to swallow when
neither Peter nor Jan had done anything
wrong. A very unhappy ending to what
should have been a good story.
This is a warning to all business owners – when it comes to asset protection strategies, you can no longer rely on what used to work. Business owners need to review their positions in light of the new bankruptcy environment and seek professional advice. Many will find that they are not as protected as they thought.
Sue Prestney FCA is spokesperson on SMEs for the Institute of Chartered Accountants in Australia.