A real concern of many people, particularly business owners, is protecting assets from creditors.

At some stage during its life, a business will be indebted to numerous creditors and the business owner may have signed a guarantee in respect of those debts.

There are several methods of protecting personal assets from creditors if debts cannot be repaid. The following list is not comprehensive but highlights several possibilities that business owners may want to consider in order to protect assets from creditors. They include:

Placing assets in a spouses’ name or in a discretionary trust

In most circumstances, creditors will not be able to make a claim upon assets owned by a spouse or held by a discretionary trust, provided that you are not the trustee (or the appointor of the trustee). If your spouse is the trustee, then he or she is the person who will usually decide how to divide up the income or capital of a trust (or not to). Stamp duty and capital gains tax issues need to be considered.

Encumber assets if you cannot transfer them

An asset that is mortgaged to its value is not as attractive to a creditor. The mortgagee in such a case is the only entity that will benefit from the subsequent sale of the asset.

Business structuring / single director companies.

It is possible to establish a company with a single director / single shareholder. In doing so, the law creates a “veil of incorporation” by which members and directors of the company have liabilities only to the amounts unpaid (if any) on any issued share capital. This liability is usually only $1.00 or so.

Only in limited circumstances can the corporate veil be lifted. The courts may be prepared to lift the veil where:

• where the company has traded while insolvent;
• there has been fraud or deception;
• there has been avoidance of contractual obligations;
• where there are good public policy reasons;
• where associated companies or groups of companies are involved; or
• under certain provisions of the Family Law Act 1975 (Cth.)

Registering fixed and floating charges over company assets to secure loans to your company

Before making a loan of money to your business (for example, an individual loaning money to a company in respect of which he / she is a director and member), a charge should be created to secure repayment of that money (in preference to unsecured creditors) in the unfortunate event that the business fails.

A fixed charge is one that fastens on ascertained and definite property or property capable of being ascertained and defined (for example a mortgage over a property).

A floating charge, on the other hand, is shifting in its nature, hovering over and so to speak “floating” over the property which it is intended to affect until some event occurs or some act is done which causes it to settle and fasten (usually called “crystallisation”) on the subject of the charge. Most charges are both fixed and floating.

Avoiding Personal Guarantees

A guarantee is a contract whereby the “guarantor” promises to answer the default or miscarriage of another person’s debt to a third party. The most common example involves a bank. The guarantor usually promises to fulfil the loan between the bank and a borrower if the borrower defaults.

Becoming a guarantor can be extremely risky, particularly when guaranteeing large debts. A common example is where parents provide a guarantee to assist children to obtain a mortgage.

Under most contracts of guarantee, the guarantor becomes immediately liable to repay the defaulted debt (that is, the guarantor is primarily liable to the banker for the debt and the bank does not have to wait for the borrower’s default before calling on the guarantee).

As a practical matter, many businesses cannot obtain finance unless a personal guarantee is provided. If this is the case, whenever the loan is repaid, the guarantee should be discharged so that the guarantor cannot continue to rely on it at a later date concerning subsequent transactions.

Superannuation contributions

In many circumstances, superannuation entitlements can be protected from bankruptcy trustees. This can be a useful protective tool so you may wish to consider discussing this with your lawyer and/or accountant. One issue with putting funds into superannuation is the restriction on accessing those funds until retirement.

Wills and powers of attorney in succession planning

What happens to a business upon the death of its principal or upon the principal losing mental capacity? The answer can be determined before these events by having a will or power of attorney.

Wills contain provisions dealing with what is to happen with your house, car and personal items however, it can also deal with the succession of your business. The type of entity which you choose to run the business (for example a company, partnership, sole trader or trust) will determine the clauses needed to effect transmission of the business in your will. Therefore it is important to seek legal advice in drafting a will to meet the object of transmitting the business. A standard form of will is normally insufficient.

A power of attorney has the effect of giving the legal powers of an individual (for example, the power to enter into a contract to sell land or obtain money from a bank account) to other persons. In this way, if the principal loses mental capacity, the business can still be operated provided the document is appropriately drafted. If the business is a company, that company may need a separate power of attorney (as the director cannot delegate his duties as a director to an attorney personally).

In addition to the above, an important personal matter than people often overlook is the appointment of an enduring guardian to make medical and lifestyle choices for you should you lose capacity. A power of attorney does not normally assist in this regard.

Contact us

We can assist you in relation to the establishment, amendment to or termination of any business structure (whether a company, partnership, sole trader, joint venture or trading trust) so as to best protect your assets from creditor claims and can liaise with your accountant, tax advisor and/or financial planner to implement any tax minimisation strategies and estate planning measures.

Call one of our Estate Planning or Commercial Lawyers for free initial telephone advice on your personal and business circumstances, estate planning and business succession planning needs on (02) 9525 8688.