Watch Out For That Forgotten Deed of Covenant
Updated: Jul 22, 2020
In this month’s case study we look at a client who had operated a residential building company.
A decision had been made by the client to exit the business as fundamentally it was no longer viable. Upon ceasing to trade, it had become apparent that inadequate Company resources were available to deal with all legacy debts of the Company. This included a material balance owing to a major bank.
Prior to approaching de Jonge Read, the client had received advice to simply place the Company into Liquidation. Fortunately, the client’s accountant referred them to us for a second opinion. On face value, the appointment of a liquidator was sound, however, it became apparent the following issues existed that had not been thoroughly considered.
The impact of these on our client would have been far reaching:
Deed of Covenant (DOC) - Through enquiries, we identified a DOC had been executed personally by the client. This was a concern as a liquidator once appointed, would seek to call on the DOC. The client’s family home would then be placed at immediate risk;
Lending Facilities - The client had outstanding business facilities with a major bank, secured by the family home. Upon entering liquidation this would create an event of default and compromise the client’s ability to personally refinance;
Personal Guarantees – a number of personal guarantees had been executed with certain suppliers holding the ability to lodge caveat on title of any real property held in the guarantor’s name;
QBCC License – The appointment of a liquidator would mean the client would become excluded from holding a QBCC license for a period of three (3) years.
We would like to note that a QBCC Deed of Covenant and Assurance (“Deed of Covenant”) may be required by the QBCC from a company director (or other associated party such as a shareholder) where a licensed building company does not have net tangible assets that meet a minimum required amount under the Queensland Building and Construction Commission Act 1991. The Deed of Covenant is a personal guarantee of the company’s debts and if required by the QBCC is necessary for the company to retain or be issued with a new or renewed building licence.
The amount guaranteed by the Deed of Covenant is the amount determined by the QBCC as being required to ensure the company meets its net tangible asset requirements and can fluctuate over time according to the net tangible assets of the company. If a building company goes into liquidation the Deed of Covenant can be called on by the liquidator.
The client was positioned to borrow against his share of equity in the family home, however, time was of the essence to complete this exercise before any defaults were listed that would compromise the approval process. Whilst the equity raised was inadequate to pay out legacy debts in full, this gave our client a war chest with which to be able to negotiate settlements.
Once funding was in place, we prepared a detailed analysis of our client’s position and specifically what return would be available in a bankruptcy scenario. With this documentation we were able to open a line of communication and negotiate a settlement outcome based on the limited resources available to our client.
Through careful project management as noted in the below points, the company was not liquidated, and finality was brought to the issues facing the director.
A full and final settlement with over 20 creditors was successfully negotiated on an individual basis, releasing both the company and the client personally;
The return to creditors was more timely and superior to the outcome that would have been achieved through the liquidation and bankruptcy process;
The Company was not placed into liquidation;
Any potential claims available to a liquidator were avoided, for example calling upon the Deed of Covenant;
The family home was protected;
Personal bankruptcy was avoided;
The client is now in a better position to manage any future claims that may otherwise arise under the home warranty scheme;
The client did not lose the right to hold a QBCC contractor or nominee supervisor license. This substantially improved his future employment prospects.
Only by carefully investigating all options and outcomes available to a client can the insolvency framework be successfully navigated. No one is better placed to assist your clients in this analysis than de Jonge Read.
FURTHER TAKE HOME
As a side note and as mentioned in our recent seminar series, Deed of Covenants (DOC) can be easily missed and forgotten. A DOC prepared years ago on the commencement of a building company can be forgotten and may no longer be necessary but by not reviewing this on a regular basis these DOC’s remain in place. Therefore, Company directors may unknowingly and unnecessarily be placing their assets at risk. We strongly urge all accountants to review their building clients to determine whether legacy DOC’s exist and if so seek to have these revoked if they are no longer required.