There is no doubt at all that Australia is becoming more litigious. We at de Jonge Read are seeing an increasing number of clients that are defending legal actions, particularly in the construction industry. Over the last few years, we have seen an increasing number of clients facing construction defect lawsuits. The knock-on effect is that an increasing number of businesses have found it more and more difficult to carry adequate liability insurance. The availability and the cost of insurance are becoming increasingly difficult to manage. Without adequate professional indemnity or other specific insurance coverage, a business could face unexpected liability from future lawsuits. However, a comprehensive asset protection strategy can reduce the risk of loss from unexpected adverse events.
Background Recently de Jonge Read was approached by an accounting firm to help one of its construction clients who had just been served with a Statement of Claim. The client was a company that had been in a drawn-out dispute over a building project which resulted in legal proceedings against the client for a claim for damages. Our client was engaged as a subcontractor on the project. Sometime after the project was completed, a damages claim was made against the principal contractor for defective work. The principal contractor settled the claim for a significant amount. The principal contractor, in turn, commenced legal proceedings against our client claiming damages for a substantial portion of the settled amount on the grounds that our client was primarily responsible for the defective work. Although our client was confident it could successfully defend the claim, the outcome of any litigation is uncertain, and by extension, risky. The insurance cover for our client did not cover the full amount of the claim against the company, leaving it potentially exposed for the balance of the claim. Up to this point, the future looked bright but the amount they were exposed threaten the viability of the company. It was a successful company with firm plans for future growth. It had a number of staff intending to purchase shares. The legal action now made the prospect of becoming a shareholder unattractive.
Problem The problem for our client was threefold:
The exposure company faced due to its limited insurance coverage.
A potentially adverse result in defending the legal action.
The concern of potential shareholders
de Jonge Read worked closely with our client’s accountant in implementing a new corporate structure so that the business could be protected in case of an adverse legal finding, and accommodate the needs of both existing, and potential new shareholders. We recognized that there was one factor in our client’s favour, and this was time. de Jonge Read was engaged within a day of the client being served with the Statement of Claim which allowed us plenty of time to help implement and project manage a strategy designed with our client.
Solution The new corporate structure would comprise an asset holding company and a trading company, thus separating risk and assets. The physical assets, intellectual property and goodwill of the company will be sold to the asset holding company. The asset holding company would then lease the assets and licence the business to the trading company. Going forward the trading company would operate the business, employ staff, lease the physical assets and premises and take on all new projects.
All the risk would lie with the trading company, so if something went wrong in the future the liability would be quarantined in the trading entity. As the assets used by the trading company are not owned but only leased to it by the holding company, they cannot be seized and sold off by a liquidator. We identified that for this structural asset protection strategy to work, firstly, the new asset holding company would need to pay fair market value for the physical assets, intellectual property and goodwill. To that end, we arranged for an independent valuer to complete a formal assessment of the value of the business. This was important to demonstrate that the sale was clearly commercial, making it unlikely that it would be challenged at a later date. Next step, a formal lease agreement for the physical assets was required between the asset holding company and the trading company to record the fact that ownership of the assets remains with the holding company, not with the trading company. This needs to be done correctly, otherwise, the assets will be assumed to belong to the trading company and a future liquidator could sell them to satisfy creditors’ claims. Therefore, the holding company registered its interest in the leased assets on the Personal Property Securities Register which acts as a public notice system for interests in personal property (which includes plant and equipment). Such registration is needed to prove that the assets, did not belong to the trading entity and therefore can’t be seized. As previously mentioned, time was one factor in our client’s favour. The court process and timetable can be notoriously slow, especially with construction matters where, as in our client’s case, scientific and expert evidence is required. As our client engaged us at the very beginning of the legal proceedings, the advice from its legal team was that it would be many months before that matter could be listed for hearing. All our client’s existing projects would be completed within the next six months. This is a relatively short time in a court’s calendar. The contracts for the existing projects would be very difficult to transfer to the trading company. Therefore, the simplest and most time-effective strategy was to complete the projects with the client company and retain enough staff to that end. Once the projects were completed the remaining staff could be transferred to the new trading company with all their entitlements intact. With this completed, if the company does happen to receive an adverse ruling in time, this may result in the appointment of a liquidator, however, the business has been commercially transitioned across and the only assets at risk would be any remaining funds from the sale to the new structure. Our client was delighted with the strategy. We were able to help transition a company facing a potential financial disaster to a structure that helps the client manage the many risks they face and provides a secure investment proposition for future shareholders thus allowing for growth.
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.
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