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Div 7A loan - the sleeping giant

December 14, 2018

 


Our latest case study looks at how we devised a strategy to manage the liquidation of a company with an insurmountable director loan (Division 7A loan). The ramifications of this liquidation resulted in a large tax debt from the company being attached to our client personally which caused further issues. This is how we brought finality to the issues.

 


BACKGROUND

 

We were approached by a client who ran a business in property sales and development. The company had an insurmountable tax debt and the ATO issued garnishee notices on all company bank accounts. 


When we reviewed the financials of the company we discovered that the director owed the company in excess of $1.0 million via a Division 7A loan account.  Various other related party creditors also owed the company smaller loan amounts. The director clearly did not have sufficient personal assets to repay the loan (due to the dramatic fall in local housing values in a mining town), nor did he want to continue trading the business. 


The major objective of the director was to retain his family home.  The director also had personally invested in seven (7) properties in various mining towns in Queensland which had an estimated market value well below the secured loan amounts.  All properties, with the exception of one property, were financed by a single lender. 

 


STRATEGY
 
After undertaking our initial investigations, it was established that de Jonge Read could provide some significant assistance to the client by managing the liquidation of the company and then dealing with both the related party debts, and the Division 7A loan.

 

As part of this process we recommended that the related party debts be settled on a commercial basis. We settled all related party loans, excluding debt personally owed by the director (Division 7A loan). 

 

The key to achieving a settlement to the related party loan accounts was to document the financial position of each of the related party entities and demonstrate that the agreed settlement amount would be higher than the return the liquidator would achieve if they pursued debt recovery action for these loans. As part of the process we undertook the following actions:

 

  • Ascertained the exact financial position of the related party debtors in order to calculate the return that could be achieved in a debt recovery action by a liquidator;

  • Offer an amount in excess of the return a liquidator would receive through a debt recovery action;

  • Document, settle and collect the offer amount (as calculated) by all related party debtors; 

  • Liaise with the company’s accountant to update the company’s financial statements to accurately reflect the repayment of all related party loan accounts; 

  • Manage the appointment of a liquidator to the company.

 

As the loan account of the director remained unpaid, in this specific case, the director incurred a substantial personal taxation liability (under the Division 7a debt forgiveness legislation) due to the company being placed into liquidation. 

 

Due to this issue, we then implemented a personal strategy for the director utilising a Part X Arrangement (Part X).  The Part X included all his personal creditors, including the liquidator, secured lenders and the ATO. By relying on an all monies clause documented in the secured property loans, we were able to demonstrate that any equity in the family home would be eroded by the sales of the seven (7) mining town properties. 

 

In documenting the Part X, it was important to demonstrate that the offer being proposed was more than would be recovered if the director was pursued to bankruptcy. 

 

To complete the Part X our firm project managed the following key actions:

  • Obtained independent valuations on the properties owned by the director to demonstrate the return to the Part X administrator; 

  • Helped formulate a commercial Part X offer; 

  • Discuss with all the secured lenders the position and inform them of the directors’ desire to retain all properties and as such seek confirmation from the lenders that the existing loan facilities could remain in place;

  • Attend creditors meeting and assist the director at the meeting. 


OUTCOME
 
As previously noted, in this case by liquidating the company it created a personal taxation liability for the client.  By entering into the Part X Arrangement with creditors, the client was able to deal with all the unpaid legacy debts of the company. 

 

The offer the director submitted, some $100K (paid by a third party) was substantially superior to the outcome that would have been achieved in a bankruptcy scenario, so the liquidator prudently voted in favour of this offer. Given the size of the Division 7A loan, the liquidator had the majority in dollar vote. The offer was accepted by creditors.
 
The action taken by de Jonge Read in this matter saved the client from having his real estate licence cancelled, being terminated from his employment, and most importantly the director retained the family home. Creditors in turn achieved a superior financial return than would have been achieved in a bankruptcy scenario. 

 

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.

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