In this month’s case study, we will look at the disastrous effect on our client of buying the shares in a company rather than the business of the company. We will also look at one of the tools the Australian Taxation Office (ATO) has at its disposal as part of its collection efforts.
Our client, Justin, had worked as a sub-contractor for a much larger business for many years. The business serviced production lines for major Australian companies. Justin knew the owner very well and they had a good relationship. Justin was approached by the owner to buy the business by way of purchasing the shares in the company as he wished to retire and this suited his tax planning. Justin did not consult his accountant and went ahead with the share purchase without getting any advice, with the outgoing director providing a vendor finance loan. Justin relied on a valuation prepared by the vendor’s accountant and a valuation of the plant and equipment. Justin paid $1.5m for the purchase with the vendor providing a loan of $1m. Justin put his life savings into the purchase, including redrawing on his mortgage over the family home.
What happened next?
The business traded well, and Justin was making good money. He made significant reductions to the vendor finance loan as agreed, making $400,000 worth of payments. As a result of the diversion of funds to the vendor finance loan, Justin got behind with his ATO payments. No big deal, he thought, the business was going great so he was confident he could arrange a payment plan. Then, around a year after his purchase, he became aware of significant claims against the company. He had been unaware that several workers were injured on a job interstate, some very seriously. Suddenly his company was facing massive litigation and a huge increase in WorkCover insurance premiums.
From there, things just got worse. As part of arranging the payment plan the ATO asked for a Debtors Ledger. Justin did not think twice about this - they probably just wanted to see what money he had coming in. Providing financial information is very common when arranging payment plans, but this can have serious implications. In his case, the ATO rejected the payment plan request. Justin was unaware that the company had a poor history with the ATO and had defaulted on numerous payment plans.
Rather than agree to a payment plan the ATO sent a Garnishee Notice to his largest debtor, a major Australian corporation. Under a Garnishee Notice the debtor is required to pay the ATO rather than the creditor. Many people know that the ATO can garnishee bank accounts but are often unaware that they can garnishee the debtors of the taxpayer. This was a serious blow to Justin’s cashflow, as he needed that money to meet his operating expenses and wages.
The next call Justin got was from his corporate client. They knew full well what the Garnishee Notice meant. With the contract coming up for renewal in a few months, the corporate client was concerned about regular supply and advised him they had decided to put the contract out for tender, something they had not done in years. Even worse, they told him he could submit a tender, but that they did not want him to waste his time and effort. Effectively, the receipt of the Garnishee Notice destroyed his relationship with his corporate client, and he lost his biggest contract.
What was the outcome?
As it turned out, the vendor did get professional advice. He had secured his vendor finance loan by registering an AllPAAP (All Present and After Acquired Property) charge over the company on the PPSR (Personal Property Securities Register). While Justin wanted to restructure the business and trade on a reduced scale, this needed the securityholder’s consent. Further, with the loss of the company’s largest contract the value of the company was reduced significantly. In fact, notwithstanding the loan payment he had made, the vendor was still owed more than the company was now worth. The vendor was still owed $600,000 with the business now valued at around $500,000. Perhaps that valuation from the director’s accountant was not that reliable after all?
Ultimately the vendor enforced his security to take control of the company. A restructure was done, with the business commencing to trade in the name of a new entity. This new trading entity was run by the vendor’s nephew. Justin was left high and dry. No business. A big loan against the family home. Scrambling to find a source of income to provide for his family.
Justin engaged de Jonge Read to deal with the personal ramifications of the failure of his business, but that is a story for another day.
The key take homes from this case study are:
Never buy the shares in an existing company. Buy the business instead. You just don’t know what claims you might be inheriting.
Always get professional advice for accounting and legal matters.
Always make sure any valuer is totally independent.
Remember that the ATO can use any information given to it in its debt recovery process.
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