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Disclaimer

This is not advice. Items herein are general comments only and do not constitute or convey advice per se. The information contained in these articles is for guidance only and should not be relied upon without obtaining professional advice having regard to your direct circumstances.

 

Legal issues with different business structures

When problems arise with a partner getting into financial problems, you need to know the implications on yourself and what can be done to protect your own interests.

If your business is run through a partnership, then you and your partners own all of the assets of the partnership jointly.  If a partner becomes insolvent, then their interest in the partnership may be realized as External Controller/Trustee.

The main difference between a partnership structure and a corporate structure is that:

• The liability of the partners for the debts of the business is unlimited; and

• Such liability is shared jointly and severally as between the partners. In other words, each partner is liable for their own share of the partnership debts as well as being liable for all the partnership debts.

When things go wrong and creditors start to chase an unpaid debt of the partnership, the creditor can sue all the partners jointly. It may be that all partners have to contribute in equal portions towards the debt.  In the worst case scenario, one partner can be made personally liable for the total debt of the partnership and if necessary, be forced to satisfy any debt from their personal assets.

Under legislation, when a partner becomes bankrupt, the partnership is dissolved. This result can be particularly harsh on the remaining partners, particularly where the partner’s bankruptcy, has little, if anything to do with the partnership itself.

Further, the court can order that the bankrupt partner’s debt be satisfied from the partner’s interest in the assets and profits of the partnership. Alternatively, at the option of the solvent partners, the solvent partners can satisfy the bankrupt’s debt to protect the partnership.

Company structure

A company is a separate legal entity to its shareholders and to its directors. Directors and shareholders are protected from the company’s liabilities incurred in the ordinary course of business, particularly where the loans have not been documented and loan monies are repayable on demand. Where a director becomes bankrupt, the director is no longer able to remain as a director. 

When a shareholder becomes insolvent, shares held by the shareholder become an asset to be realized by an External Controller/Trustee. Shareholders (in most cases) have the right to appoint directors and it may be that the directors are forced to deal with an unknown person at board level who is appointed by an External Controller/Trustee.

Loans and guarantees

It is common that a business is financed by way of loans from its shareholders or partners. If the lender becomes insolvent then these loans may be called in by an External Controller/Trustee which may have a disastrous effect on the business. Similarly, if you have provided joint guarantees then you may find yourself in breach of those guarantees as a result of your business partner’s insolvency.

If you are concerned about the financial viability of one of your business partners you should consider the following:

• Where your business is run through a company, you can enter into Shareholders Agreement with your business partner. The agreement can place restrictions on using shares in the company as collateral for a mortgage.

The agreement can also place restrictions on transferring shares which would equally apply to an External Controller/Trustee who later obtains rights to those shares. You may even provide for the shares to be redeemed by the company or subject to pre-emptive rights in favour of the remaining shareholders should one shareholder go bankrupt.

• Where your business is run as a partnership, entering into a partnership agreement which provides similar restrictions as outlined above.

• Where you have provided joint guarantees with your business partners, then review those guarantees to determine what effect your partner’s insolvency may have you and your business. Negotiating “several” guarantees with financiers may protect you.

In all cases, reviewing existing loans by shareholders to the business and entering into written loan agreements which provide a defined payment schedule for these loans is critical.

Where appropriate, shareholder loans should be secured by Registered Mortgage Debentures to ensure priority over other unsecured creditors.

John Sier
My Business, February 2009

 


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