We often see cases where a related party, like a director or family member, has lent considerable sums of money to a company but has not taken a security interest relating to their loan. The outcome in these cases can be heartbreaking, especially when a family member suffers a loss.
In many cases, these loans are made because the bank will not provide any more funding and the business is out of financing options. Often the related party ends up as the major lender, advancing more funds than the business’s bank, but they have no security at all.
That leads into this month’s case study. A few years ago, our client, Nigel, met with his accountant for his company’s annual reporting. The accountant knew de Jonge Read well and had attended previous seminars and webinars. At the review, the accountant discussed a recent loan made to the company by the director. She knew the value of having security for the loan but was not an expert in this area and was not on top of all the details. She referred the client to de Jonge Read for an obligation and cost-free assessment of the situation.
At that time, we recommended:
A written loan agreement be prepared, covering issues such as events of default, triggers for repayment, the interest rate to be applied, and the method of calculating interest;
A security interest to be taken over the company and registered;
An acknowledgment that future lending would be subject to the same agreement up to an agreed limit amount; and
Evidence is maintained to show that the funds were received by the company and the source of those funds (such as bank statements from the lender and borrower).
There are two common types of security interests, as follows:
PMSI Purchase money security interest; and
AllPAAP All present and after-acquired property.
A PMSI is a specific security interest over an asset. For example, a motor vehicle. An AllPAAP applies to all property owned by a company and can cover circulating assets, such as stock and debtors, as well as non-circulating or fixed assets. This type of security ranks behind a PMSI.
A lender with a PMSI security over a specific asset has the absolute right to the proceeds from the sale of that asset up to the amount they are owed.
In Nigel’s case, we were talking about registering an AllPAAP. A lender with an AllPAAP has priority for the proceeds of the sale of any assets once any PMSIs have been dealt with.
Nigel at the time was not that keen to proceed with this action as there was a cost. The accountant pushed and finally Nigel engaged, and the security was ultimately registered.
Fast forward to the end of 2022 and Nigel’s company had to consider some formal insolvency options due to the effects of Covid. The business suffered a slowdown in sales during the Covid period and whilst the business had returned to normal, Nigel had incurred an insurmountable debt to unsecured creditors, predominantly the ATO.
Our Strategic team devised a strategy that included a restructure (sale of the business to a related entity) for commercial value and due to the fact that Nigel was the 1st ranking secured creditor, the majority of the purchase price was simply offset against his security interest.
There are rules about the timing of registration and the effectiveness of a security interest. These can be complex, and we would be happy to provide further information on these issues that is specific to the individual circumstances in each case.
I am certain you can understand the appreciation that Nigel has for his accountant due to the extra care and due diligence in steering him in this direction a number of years beforehand. The accountant’s advice has literally resulted in saving Nigel, hundreds of thousands.
The team at de Jonge Read can provide comprehensive project management services to ensure that the security interest and all related documentation are accurate and that the whole process is managed efficiently.
If you are a professional advisor and see a loan from a related party on a balance sheet, or a company director that is considering making a loan to the company or asking a family member for assistance, you should seek advice now. Giving your client that extra attention now could literally save them an enormous amount of money should something go wrong in the future. Great Insurance.
We offer an obligation and cost-free consultation on all options that may be available, including helping to arrange an appropriate loan agreement and security interest.
Should you have clients or associates that you know are struggling with financial issues or need assistance in reviewing their business affairs in preparation for what’s around the corner, our team of Strategists would be pleased to discuss options that are available on how to best design and implement insolvency strategies.
Contact us now on p. 1300 765 080 | firstname.lastname@example.org