Australia continues to resist falling into “technical” recession – measured as two consecutive quarters of negative growth – and unemployment remains logic-defyingly low.
However, our small and medium business clients are telling us that these are tough times. This anecdotal evidence is borne out by the hard data – ASIC’s latest insolvency figures indicate that 7,742 companies entered external administration over the period 1 July 2023 to 31 March 2024, a 36.2% increase on the previous corresponding nine-month period ending 31 March 2023. It is likely that when the figures are in, some 10,000 companies will have entered external administration in the 12 months to 30 June 2024, a level not seen since the 2012-2013 financial year.
Times like these force business people to examine their financial vulnerabilities, and one of the most common of these is the extent to which their personal wealth is tied up in their business.
It’s a common story – you started a business a few years ago, you and your partner as the shareholders in your company, you as the director. To give the business a kick-start you used your personal savings as working capital. The idea was that as the business grew it would fund itself, and the original “personal” money you provided would be withdrawn. The simplest way of doing that would be to put in the start-up money as a loan to your company, not share capital. That way, it can easily be repaid as the company grows.
Somehow, that just didn’t happen. The business grew, but the loan wasn’t repaid. Rather, from time to time you put in a bit more “personal” money, to fund expansion, or simply to tide over the short-term cash shortages that every growing business experiences. The original loan just sat on the balance sheet of your company as a liability, and increased over time, rather than being paid back.
You never gave much thought to taking any security from the company for the loan, because it seemed unnecessary – you control the situation, it would be like taking security from yourself. Also, at some stage you may want to obtain external finance, from a bank, and having a security in your favour over the company would just be a nuisance.
However, fast forward to 2024, things are looking a bit bleak. A major customer has unexpectedly fallen over. You have committed to buy raw materials from your overseas supplier to meet expected orders from that customer – the orders have dried up, but you still have to pay your supplier.
You think it’s time to look at protecting your – and your family’s – financial position. Perhaps your accountant suggests that you should consider taking security over the company’s assets – mainly inventory and some plant and equipment, perhaps some intellectual property – and register it on the Personal Property Securities Register (PPSR).
What You Need To Know About The PPSR
Click here to explore what the PPSR is, who it can help, the types of property you can register and where to get started.
At least, you think, if the worst happens, and the company folds, you have the inside running to get your debt repaid from the liquidation of the company’s assets. Surely this is fair enough, the company has had the benefit of your money for years, aren’t you entitled to protect yourself?
If a company heads into troubled waters and becomes insolvent, any unsecured monies advanced to the company by the director will be treated as an unsecured debt along with all other trade creditors who have not been granted security by the company.
This means that any recovery from the sale of the assets is distributed according to the statutory requirements as set out in the Corporations Act 2001, which specifies secured creditors (such as banks) as the top priority for repayment, versus unsecured creditors who are last on the list.
Unfortunately, you may be too late. Section 588FP of the Corporations Act 2001 stipulates that a security in favour of a director of a company is unenforceable in the six months after it is granted, unless the Court approves otherwise. This restriction extends to people and entities associated with the director – such as a family member or a family trust.
If things are as bad as you fear, you may not have six months – it is an old saying in the insolvency industry that companies go broke very slowly, and then very fast.
Section 588FP gives the Court power to enforce the security if the company was solvent immediately before the security was granted, and it is “just and equitable for the Court to do so”. What is “just and equitable” will vary with circumstances – but the chances are that by the time you start thinking about taking security, the company is actually insolvent – things always appear worse in retrospect.
Some Tips That May Help Protect Your Assets As A Director:
- Plan the structure ownership of your personal assets so it is optimal for both asset protection and taxation purposes.
- Separate your trading entities from your asset holding entities.
- Transfer personal property to a low-risk party (such as your spouse) or into a discretionary trust.
- Place any contributions into a superannuation fund.
Therefore, the question is: what can you do to protect yourself as a shareholder/director who is thinking about lending money to the company?? If you are putting start-up money into your new business, do as a bank would do and take security at that time. After all, if a bank worth billions won’t lend you money without security, why should you risk your personal wealth?
Most new businesses can last six months, so as long as yours does, the security will be effective if the need arises. Security can be taken in a variety of ways: as a mortgage over land owned by the company, as a “general security over assets of the company generally (often referred to as a “company charge”) or even as a specific security over a particular asset (such as an item of equipment). Mortgages over land must be registered at Land Registry Services NSW (or the equivalent registry in other jurisdictions), all other securities should be registered on the Personal Property Securities Register (PPSR). You can read more about the PPSR here.
If you do need to get outside finance, you can always give the financier’s security full priority, but your security will remain in place.
Chances are you will probably never need to call on the security, and if you do there is no guarantee that you will get your personal money back. But by taking a few straightforward steps you will have at least given yourself the best chance of a fair payback!
Please contact us with any questions you may have about how to protect yourself and your business.