PERSONAL GUARANTEES - DO YOU KNOW WHAT YOU ARE SIGNING
Daniel Luckman Associate Director | Sunshine Coast
Corporate insolvency, including the latest Small Business Restructure (SBR) process, often has wide reaching implications for directors that may not be known until it is too late and financial difficulty arises.
Generally speaking, directors are not liable to pay company debts; there are however some exceptions, including when a personal guarantee is provided for the company’s debt.
So, the question is, do you really know what you are signing when it comes to providing a personal guarantee?
We often encounter directors who are surprised about the implications of signing a personal guarantee. Below we have explained some of the key aspects of personal guarantees that are often missed.
What is a personal guarantee?
A personal guarantee is a legal commitment by an individual (usually a company Director) to pay a debt primarily owed by another party (a company or other individual) if that party does not pay the debt.
Most people understand the basic concept of providing a personal guarantee but there can be some unintended and unexpected consequences.
Supplier Accounts
To provide goods and services on credit to a company (i.e. a credit account), a supplier will usually provide a credit application form along with their accompanying terms and conditions.
A personal guarantee (PG), with its own terms and conditions, may also be required by the supplier to open the credit account in which the guarantor (usually the Director) will guarantee payment of any outstanding invoices if the company does not pay them in full (if for example, the company is placed into liquidation). There can also be liability for interest and costs incurred by the supplier.
Imbedded in the detail of the terms and conditions of the PG, is often a term commonly referred to as a “Charging Clause”. That Charging Clause will say something to the effect of “the Guarantor charges all of their real and personal property to secure payment of the money owed pursuant to the guarantee they have provided”.
The terms and conditions of the PG will also usually permit the supplier to lodge a caveat on the title of any real property to secure payment of the debt pursuant to the Charging Clause. Upon an insolvency event, such as the liquidation of a company, it is not uncommon for these parties to immediately register caveats on any real property owned by a guarantor. So effectively, when you sign the PG you can be giving security over your property, like a mortgage to a bank!
Banks and Financiers
General Secured Loans
Banks and major financiers will often obtain security against real property for loans and finance facilities provided to companies that operate small to medium businesses.
These loans (e.g. an overdraft facility) will often be secured by real property that may be owned by the primary borrower (the company) or a Director personally through a personal guarantee (such as their family home). The security is normally provided in the form of a registered mortgage; so, as a Director, you would be well aware the bank or financier will have rights to enforce payment of the debt owed by the company against the mortgaged property.
Specifically Financed Assets (Chattel Mortgages / Finance Agreements)
If a bank or financier has provided funding to a company to purchase a specific asset (such as a motor vehicle), they will usually also obtain a personal guarantee from a Director.
Whilst the bank or financier will normally obtain security against the asset purchased (the motor vehicle), if the company defaults on payment of the finance payments, the financier can repossess and sell the asset. If after the sale of the asset there is not enough money to pay the debt owed to the financier, the balance owed is referred to as a Shortfall Amount. There can also be liability for interest and costs incurred by the financier which can be added to the Shortfall Amount.
This Shortfall Amount can be pursued by the bank or financier against the guarantor. Again, as for the earlier examples, this personal guarantee may contain a Charging Clause which would entitle the bank or financier to be secured against property owned by the guarantor and to lodge a caveat against the property.
Unsecured Loans
There are some financiers and lenders that specialise in providing loans to companies that do not require a company to provide any security against its assets.
That does not mean they do not obtain any security at all though.
These financiers and lenders often seek personal guarantees from the directors of the company (and sometimes other family members). Those same Charging Clauses noted above can form part of this personal guarantee.
The practical implications of this are that instead of providing security against the company, a Director (or other family member) may have inadvertently provided security against their personal property (such as their family home) if the company cannot pay the debt.
Takeaways
Personal guarantees are sometimes a necessary part of business. It is however always best to properly consider and obtain advice on the terms and conditions of personal guarantees before they are signed, regardless of the urgency of obtaining funding or finance. If no longer involved in the business, the director must inform the suppliers and financiers and seek the release of the guarantee.
If you or your client are facing financial difficulty and personal guarantees have been provided for company debts, we encourage you to reach out to your local SV Partners’ office for appropriate advice – your assumptions may not be correct.
DIRECTOR PENALTY NOTICES EXPLAINED
Andrew Allemand - Senior Manager | Brisbane
Background
The Australian Tax Office (ATO) has implemented the Director Penalty Notice (DPN), a regulatory mechanism designed to enforce the tax compliance of company directors. This instrument plays a critical role in ensuring that directors are held accountable for the tax obligations of their companies, by allowing the ATO to recover certain company debts from its director(s) particularly in relation to:
• Pay As You Go (PAYG) withholding;
• Goods and Services Tax (GST); and
• Superannuation Guarantee Charge (SGC) liabilities.
Receiving a DPN is a serious matter. Once the notice has been issued, you have a limited timeframe to respond and avoid personal liability. Given that company debts are often large in scale, personal liability for company debts can bankrupt directors.
The best way to avoid this outcome is to meet your obligations as a Director and stay abreast of the company’s financial situation and to seek advice from experienced professionals such as your accountant or solicitor and SV Partners as soon as possible.
In this article, we discuss DPNs and how you should respond if you receive a notice from the ATO.
Historical Context
The concept of DPNs was introduced as part of the Tax Laws Amendment (2012 Measures No. 2) Act 2012. This legislation was aimed at mitigating risks associated with phoenix activities, where companies are deliberately liquidated to avoid paying debts, and subsequently re-established under a new name.
Purpose and Objectives
The primary objective of DPNs is to ensure that company directors remain personally liable for their company's unpaid tax debts. This measure is intended to promote responsible corporate governance and prevent the accumulation of tax debts that could negatively impact employees and the broader economy.
Mechanism and Enforcement
Issuance of DPNs
A DPN can be issued when a company has failed to meet its PAYG withholding, GST or SGC obligations. The ATO can issue two types of DPNs. The way you respond to a DPN depends on whether you receive a Non-Lockdown DPN or a Lockdown DPN.
Essentially the ATO provides directors with 21 days from the date of the DPN to comply with the obligations set out within the DPN. Failure to comply within this period results in the automatic imposition of personal liability on the Director.
Two Types of DPNs
There are two main types of DPNs:
• Non-lockdown DPNs: These are issued when the company has lodged its Business Activity Statements (BAS), Instalment Activity Statement (IAS) within 3 months of their due date but failed to remit the payments or SGC statements by their due date (or they will become lockdown DPNs).
If a Director receives a non-lockdown DPN, they can avoid personal liability by using the company to take one of the following actions within 21 days:
• Paying the debt in full
• Appointing a Voluntary Administrator
• Appointing a Small Business Restructuring Practitioner
• Appointing a Liquidator
Unfortunately, directors are unable to avoid personal liability by entering into a payment arrangement with the ATO once the DPN has been issued. If you do enter an ATO payment arrangement, you will still be personally liable for the debt at the end of the 21-day period.
• Lockdown DPNs: These apply when the company has not lodged its BAS and IAS within 3 months of their due date or SGC statements by their due dates.
In such cases, directors become automatically liable for the company's tax debts, and the ATO may pursue them for recovery irrespective of any subsequent actions taken by the company.
The only way to avoid personal liability is to immediately (within the 21-day period) repay the full amount of the debt.
If the company is unable to pay the debt, the Director immediately becomes personally liable.
Implications for Directors
The imposition of a DPN has significant implications for directors. It underscores the importance of timely and accurate tax reporting and remittance of same. Directors must be vigilant in their oversight of the company's financial obligations to avoid personal liability.
Additionally, in cases where directors are unable to ensure compliance, they must consider proactive measures such as paying the debt amount in full, the appointment of an administrator, liquidator or small business restructuring practitioner to the company to
mitigate their risk.
How the ATO Recovers Director Penalties
Issuing a DPN is the first step when the ATO intends to recover unpaid company taxes from its directors. Once the DPN is issued, the ATO can recover the amount by:
• Issuing a garnishee notice – A garnishee notice allows the ATO to collect the debt directly from a debtor of the director. This includes banks and financial institutions, your employer, or other people who owe you money.
• Offsetting your tax credits against the Director penalties – Tax credits such as an income tax return can be applied directly to the Director penalty.
• Initiating legal proceedings – The ATO can pursue the unpaid debt through the court. This may involve bankruptcy proceedings against the Director.
Defences and Relief
If you dispute the amount of the DPN, you may be able to seek relief of same. Directors may be able to avoid liability under certain circumstances where a Director has a genuine defence. You are not personally liable for the debt where:
• You did not take part in managing the company during the relevant period. For example, if you were unwell and absent from the company during the period relating to the unpaid PAYG, GST or SGC or were appointed within the 30 days prior to the tax obligation becoming due.
• You took all reasonable steps to ensure the company paid the outstanding amount, or that the company appointed an Administrator, Small Business Restructuring Practitioner or Liquidator.
These defences are only valid if they can be proven for the entire period during which you were responsible for managing the company.
Non-participation in the management of the company may still constitute a breach of your duties. While this defence can protect you against tax and superannuation debts, it may open you up to other personal liabilities.
Conclusion
DPNs serve as a crucial enforcement tool for the ATO, aimed at fostering a culture of compliance and accountability among company directors. By understanding the implications and mechanisms of DPNs, directors can better navigate their responsibilities and safeguard their personal and professional interests.
HOW PROPERTY MATTERS IN BANKRUPTCY
Brett Harron - Senior Manager | Gold Coast
Real estate is often our most significant life investment. People form sentimental attachments to their family homes, and will go to great lengths to safeguard it.
If property does fall in the hands of a Bankruptcy Trustee (Trustee), the interest of the Bankrupt vests in the Trustee and the Bankrupt cannot deal with their interest. What options are available for a Bankrupt to save their property?
In a bankruptcy, property matters to:
1. The Bankrupt – What can I do as a Bankrupt to keep my property?
2. The Trustee – What are the considerations for a Trustee when selling real property?
1. What can a Bankrupt do to keep their property?
When a property owner is made bankrupt, their greatest fear will often be the loss of their family home. However, there are still pathways which may allow for the Bankrupt to retain their property. The first option is to pursue an annulment of the bankruptcy. Alternatively, if the property is jointly owned, the co-owner could purchase the interest from the Trustee.
Annulment of the bankruptcy
There are two methods available for the annulment of a bankruptcy:
i. Putting forward a proposal for creditors’ consideration and approval. The proposal will typically include payment or payments to the Bankrupt Estate which would result in a greater return to creditors than would otherwise be achieved through the ordinary administration of the Bankrupt Estate; or ii. Making payment of all debts of the Bankrupt Estate in full. This includes the Trustee’s fees and costs up to the date of annulment, interest on interest bearing creditor claims and realisations charge payable to the Australian Financial Security Authority.
Both instances would avoid the sale of the property, which would be retained by the Bankrupt.
In pursuing these outcomes, a Bankrupt typically raises funds external to the bankruptcy from family or friends. Alternatively, if sufficient equity exists in the subject property, a Trustee may consider allowing the Bankrupt to refinance the property to source the requisite funds. A Bankrupt must make prospective financiers aware of the bankruptcy (it is an offence to not disclose a bankruptcy when obtaining credit over a limit (currently $7,032)). Provided the amount loaned is sufficient to annul the bankruptcy, financiers generally will consider approving the finance, assuming other serviceability criteria are met.
Sale of a Trustee’s interest to the co-owner
Where a property is jointly owned, the co-owner can purchase the Trustee’s interest in the property for market value. The interest in the property is sold by way of a Deed of Transfer. Under this method, a mortgage and other encumbrances will remain in
place and these, as well as any other levies (such as council rates), will become the co-owner’s liabilities.
When considering offers provided by a co-owner, a Trustee should factor in such things as the property’s market value, any encumbrances attributable to the Bankrupt, and the costs saved by not selling the property on the open market (including the agent’s commission and marketing costs). If the co-owners offer exceeds the Trustee’s estimate of the Bankrupt’s interest through a sale on the open market, they should accept the offer. A Trustee is not required to communicate their calculations to a co-owner, as this would prejudice any offer provided by a coowner.
The only additional costs to the co-owner would be the stamp duty that may be payable on the transfer, and the mortgagee’s fees when registering the transfer on title of the land. This may be a small cost in comparison to losing the property altogether.
The above two are some valid ways a Bankrupt can ensure the property remains ‘in the family’ after becoming Bankrupt.
The dishonest Bankrupt
It is not unusual for a party facing bankruptcy to make a rash and desperate attempt to protect their family home. Desperate times calls for desperate measures! This comes in many forms, including:
• Transferring an interest in the property to their spouse below market value, or for no consideration whatsoever;
• Creating fictitious or overstated encumbrances through family members or other parties; and
• Using Family Law provisions as a vehicle to divert assets.
The Act provides Trustees with wide powers to set aside such transfers. Following an appointment, Trustees undertake investigations into such matters and may take steps to set aside any voidable transactions identified. It also bears mentioning that such activity may constitute an offence under bankruptcy and the maximum penalty for contravention includes imprisonment for up to five years.
2. What are the considerations for a Trustee when selling real property?
A Trustee has a duty to recover property for the benefit of the estate. Property is defined to cover all divisible assets, not just real property. BUT is the Trustee’s duty to realise property, governed in any way?
All Trustees must follow certain performance standards that are set out in the Bankruptcy Act 1966 (Cth) (the Act). Section 19 of the Act also provides a duty on Trustees to take reasonable steps to recover property for the benefit of the estate. Further guidance on Trustees’ administration of Bankrupt Estates is provided by the Australian Financial Security Authority (AFSA), which is the government body responsible for the regulation of Bankruptcy.
Relevantly, a Trustee has a duty of care to ensure
the interests of creditors and the Bankrupt are considered, which requires the Trustee to sell the property at market value.
As the name suggests, market value is dictated by the market. In the event of a sale on the open market, a Trustee should undertake the following to ensure market value is obtained:
• Obtain market appraisals and sales and marketing campaigns from multiple real estate agents;
• Select the most suitable agent based on the appraisals and campaigns. This includes setting an appropriate price to market the property and determine the best method of sale, either private treaty or auction;
• Commence the marketing campaign in accordance with the appointed agent’s recommendations; and
• Before an auction, consider setting a reserve.
If dealing with a difficult co-owner, the Trustee should also consider engaging a registered valuer to prepare a formal valuation report. This report can assist in showing the Trustee sold the property for market value. Additionally, the Trustee should obtain a formal valuation report when selling a Bankrupt’s interest to a co-owner, as this will satisfy creditors that market value was obtained.
As long as the Trustee can show he or she took all steps to sell at market value, the interest of creditors and the Bankrupt are protected (as well as the Trustee’s interest).
Where co-operation is refused
What options are there for a Trustee to sell real property where the Bankrupt and/or the co-owner refuse to co-operate with the Trustee?
If the Trustee is unable to obtain vacant possession of the property with the cooperation of the Bankrupt and other occupants, they must seek an Order from the Court to obtain vacant possession. This may result in authorities attending the property to forcibly evict the occupants.
If the co-owner refuses to cooperate with either a joint sale or the acquisition of the Trustee’s interest in the property, then the Trustee will be required to seek the appointment of a Statutory Trustee for the sale of the property. Under this appointment, the co-owner has no control over the sale and there is also potential for the Court to Order the costs of the application be paid by the co-owner.
We at SV Partners are well versed in sale of properties (with all likely scenarios) including a sale where Statutory Trustees are appointed.
If you wish to speak to an expert in relation to any real property concerns, please call 1800 246 801 or visit svpartners.com.au for more information.
Nirav Shah - Manager | Perth
In her article of 27 June 2024, our Rebecca Patel gave an overview of garnishee orders and how they work. This article picks up on that background and shares our recent experiences with garnishees in both corporate and personal insolvency.
Parties cannot issue a garnishee notice after an insolvency has commenced, with the statutory protection founded in sections 440B and 471B of the Corporations Act 2001 and section 58(3) of the Bankruptcy Act 1966, except with the leave of the Court and in accordance with such terms (if any) as the Court imposes. However, a Bankruptcy Trustee can issue a garnishee notice against the regulated debtor (bankrupt) in certain circumstances, principally to recover income contributions owing by the bankrupt and only with the approval of the Australian Financial Security Authority (AFSA). Certain parties can also rely upon already existing garnishee notices issued prior to an insolvency to collect on their debt after an insolvency has commenced.
Where the Australian Tax Office (ATO) has previously relied upon Director Penalty Notices as a lever to collect upon corporate tax debt (by claims against directors), they are also now more heavily relying upon garnishee notices to collect from companies’ bankers and customers. This is particularly disruptive for business especially when funds are held in the company bank account to meet a monthly salaries/ wages bill, but the funds are not available due to an ATO garnishee. Think of it as the direct debit from the company account that the directors did not sign on for.
Where cashflow is the lifeblood of most business, the garnishee notice can derail the otherwise orderly flow of payments. To avoid that scenario, when there is financial distress, proprietors should seek to enter payment arrangements with the ATO and work steadfastly to honour those arrangements. Once breaches of payment plans occur, garnishee of funds by the ATO is common. Accordingly, please reach out to your local SV office to discuss any client situation where payment plan breaches are anticipated. The appointment of an administrator, liquidator or restructuring practitioner might better secure the company cashflow in the interests of employees and the wider creditor group.
Interestingly, garnishees in favour of the ATO (or more pertinently, the funds that flow pursuant to them) have been held by our courts not to be capable of being overturned/avoided by a liquidator/bankruptcy trustee i.e. not in the way that a preferential payment is obtained by a creditor issuing a statutory demand or commencing a winding up application - DFC of T v Donnelly (1989) ATC 5071; Macquarie Health Corp Ltd v FC of T (2000) ATC 4015
Once a garnishee notice is issued by a statutory authority, our advice is that the ATO or State Revenue Office (SRO) will have the power to continue to collect upon the notice even if a liquidator/trustee is appointed. That said, we do try to negotiate a waiver of these rights by the respective tax collection agency, with some success in the right circumstances.
We have seen 2 recent bankruptcies where the ATO
issued a garnishee to the debtor’s employer prior to each bankruptcy and the ATO continued to see their respective wage heavily docked for more than a year after the bankruptcy. The debts were greater than $1M in each case, so the garnishees would have continued for years (even after the bankruptcies) except that each bankrupt quit their jobs and got new roles. The change of employment was the re-set they needed bringing an end to the garnishee notice with the comfort that the bankruptcy meant that a new garnishee could not be issued.
We have also dealt with SRO garnishee notices to debtors of the company prior to the liquidation pursuant to section 65(1) Taxation Administration Act 2003 (Cth) (the Tax Act). SRO’s garnishee notices were in relation to outstanding payroll tax as a result of an audit on the company’s books and records and determined that the contractors were deemed to be employees of the company. Therefore, payroll tax was payable.
Our advice was that the SRO’s garnishee notices were flawed as they did not meet the criteria pursuant to section 65(2) of the Tax Act. Subsequently, SRO withdrew the notices, however, retained the sums collected under the flawed notices. Following legal advice and correspondence to and from the SRO, ultimately the monies collected were repatriated into the liquidation enabling us to pay outstanding superannuation. It is noteworthy that this was only possible as the garnishee notices were flawed, and the SRO was interested to see the rights of employees protected in the circumstances.
On September 10th, Michael Brennan from our Townsville office took part in this year's Out of the Shadows Walk, walking 9 kilometers for the 9 Australians who lose their lives every day by suicide.
Michael promised to bring back the business casual wear look to Townsville if he raised more than $2000! (Donations have now surpassed $7000! We are looking forward to seeing Michael's stylish fit soon around town soon.)
Well done Michael!
