Updated: Feb 4, 2021
In this month’s Case Study we look at some of the pitfalls experienced by a client, who, against his Accountants advice, managed the exit of a business along with his personal liabilities without professional planning and support. As they say, you can lead a horse to water, but you can’t make it drink.
Craig purchased a mechanical repair business in a corporate entity from the previous owner-operator. As he was not a qualified mechanic, he performed a managerial role in the business. Despite Craig’s best efforts, the business struggled from the outset. The added expense of not being an owner operator was a terminal issue for this business in its current format. Over time, the business fell into arrears with trade creditors and tax obligations. As problems began to mount Craig realised he needed to exit the business.
I’ve got this covered!
Craig and his wife, Jane, had some cash left from the sale of an investment property and the business was considered saleable. Craig was confident that he could exit the business and deal with his personal guarantee liabilities from the available funds. His accountant was not so sure, and recommended Craig meet with de Jonge Read to discuss what options might be available. Craig did not heed that advice.
The business was listed for sale and Craig entered negotiations with his creditors on an ad hoc basis. His approach was to start with his biggest trade creditor, reach agreement with them, then work his way down the list. No consideration was given to the personal guarantee position of Craig. As he reached an agreement with each trade creditor, he made payment and received a written acknowledgment. There were no payments made to the ATO at all.
Success. The business was sold on a walk-in-walk-out basis. Craig received a small amount of cash, with the remainder of the purchase price under a vendor finance arrangement. Craig had his solicitor prepare a standard sale contract and finance agreement. Unfortunately, he did not take any security over the purchaser’s company for his vendor finance loan.
Craig went back to negotiating with creditors. Soon, the cash he had available was almost exhausted, and he still had more creditors to deal with. He planned to deal with this from the vendor finance payments.
Craig’s problems then went from bad to worse. One of these creditors, an automotive paint supplier, was not happy with Craig’s offer. He was even less happy when Craig told him he had sold the business, including the stock. The problem was that the creditor had a registered security interest over the stock that Craig had sold, a PMSI, and they did not approved the sale. The creditor rang the new owner and asserted their right to the stock. This led to a legal dispute between the parties, with the purchaser refusing to make any further payments to Craig under the vendor finance agreement.
With little cash left and remaining creditors now chasing payments hard, Craig went back to meet with his accountant. This time, thankfully, he did follow the advice to meet with de Jonge Read.
Maybe I do need some help after all
By the time Craig met with us his position was untenable. The ATO was in the process of appointing a liquidator to the company.
The problem was that Craig had distributed the cash available to creditors without regard for priority and security positions or personal guarantees that he may have given. We knew that, on appointment, the liquidator would look at any payments that had been made to an unsecured creditor in preference to other creditors. This could expose Craig to claims from personally guaranteed creditors he thought he had dealt with.
We reviewed the creditor settlements that Craig had undertaken. The amounts paid were inconsistent in percentage terms. Some had got more; some had got less. Further, none of the settlements were based on the return the creditor would get if they pursued a recovery action. It was more a case of Craig paying them the minimum they said they would accept, with no compelling argument made as to the commerciality of the offer.
Cash had been exhausted and Craig faced more personal liability after the expected liquidation of the company. In the circumstances we recommended Craig enter bankruptcy in an organised and controlled manner. In next month’s case study we will explain how we guided Craig & Jane and helped bring finality to the claims and retain the family home in bankruptcy.
The message to this month’s case study is for our referrers to always be mindful of the dangers that your clients could be facing in managing a controlled exit.
Should you have clients or associates that you know are struggling with financial issues, our team of Strategists would be pleased to discuss options that are available on how to best design and implement insolvency strategies. Call us now on: 1300 765 080.