From our experience, many company directors and small business owners are oblivious to their obligations and duties and do not consider the downside or risk, particularly through their personal exposure, should things go pear shaped financially.
Sadly, if the ramifications are severe enough, it could lead to the bankruptcy of the small business owner or a company director. In fact, we often hear the line “had I known that I would have looked at different options”.
For the purposes of this article, let's focus on the risks associated with being a company director, although many of the risks are just as relevant for a small business owner.
The most common risks company directors face are personal guarantees (which may include charging clauses over property), secured creditor claims (which generally have been personally guaranteed), director loan accounts, personal liability for unpaid PAYG withholding tax and superannuation, insolvent trading and other potential claims that can be pursued by a liquidator.
So what is the impact when a director does become exposed to personal liability as a result of the failure of their company? Part of the answer to that question depends on whether, and how well, the director has structured their personal affairs from an asset protection planning perspective, with that potential outcome in mind.
Asset protection is about separating adverse risk from a person’s assets — this means still being able to have some control over those assets even though the person does not legally own them, so if they are sued those assets won’t be available to creditors or a bankruptcy trustee.
In any asset protection strategy, the first thing often considered is the cost. Perhaps the question to ask your client is “what is the potential cost of not planning for asset protection?”. The answer to that is simple — they could very well lose everything. In that sense, an asset protection strategy is much like an insurance policy, although most of the cost will be incurred at the beginning of the process.
As for some simple, but effective tips to give your clients who wish to become (or are already) a company director on protecting their hard-earned wealth:
- Know and understand how their business structure works — have a strong discipline about how the structure is administered to avoid the benefits of the structure being exposed.
- Carefully read and understand all contractual documentation (such as terms of loans, lease and supply agreements etc), and negotiate before agreeing to them.
- Limit any personal guarantees — keep a register and put a maximum limit on any guarantee given.
- Never own assets — transfer any assets you do own as soon as possible (and before taking on any potential risk).
- Have a good reason for the transfer other than “asset protection”.
- The best approach is to ensure any asset transfers are for full market value and actual real consideration (to minimise the risk of the transfer being set aside at a later date by a bankruptcy trustee).
- Ensure the at-risk person does not make any direct financial contributions to assets or servicing of debt — the not-at-risk-person holding assets needs their own income to service the debt.
It is important to remember that there is no perfect asset protection structure, and consideration must be given to the specific circumstances, balancing of priorities and defining what is most important. It should not only consider the business risk (and holding appropriate insurance cover to mitigate those risks), but also family law, business succession planning, and estate planning. And lastly, asset protection planning frequently evolves so it is worthwhile scheduling a regular review much like one would do for tax planning purposes.
Ivan Glavas, partner, Worrells Solvency & Forensic Accountants