23 Nov 2017Most businesses that are operated as a company or trust are required to provide directors’ guarantees to creditors. That is, the directors of the company that operates a business, or the directors of the corporate trustee of the trust that operates the business, are required to personally guarantee payment by the business for the goods and services supplied to the business by creditors.
Passing control of a family business to the next generation
When control of a family business passes from one generation to the next, it is important that personal guarantees given by members of the retiring generation are not overlooked.
For example, if Susan Smith passes control of her business S Smith Pty Ltd to her son Jack, she needs to make arrangements with creditors of the business for Jack to give personal guarantees to replace personal guarantees previously given by Susan. If Susan does not do this, she will remain personally liable for debts owed by the business to these creditors should the business become insolvent after she retires.
No doubt, having her home and other assets made available to creditors of the business is not what Susan had in mind when she retired from the business and passed control of it to Jack.
Unreleased personal guarantees may extend beyond the next generation
This problem of ongoing liability for unreleased personal guarantees is not limited to one generation. In the example above, if Susan originally acquired control of the business from her father Stephen, then unless personal guarantees previously given by Stephen to creditors of the business were released at the time control of the business passed from Stephen to Susan, Stephen may also be liable to creditors of the business for debts arising after control passed from Susan to Jack.
Stephen will be most unhappy about receiving notices of demand from creditors of the business in which he has not had any ongoing involvement for many years.
Retired directors should not be exposed to claims by creditors of the business
Family businesses can fail for all sorts of reasons, including an economic downturn, a changing market or the management skills of later generations proving to be not as good as those of previous generations. Whatever the reason, it is essential that if a family business fails, previous generations do not find themselves exposed to claims by creditors of the business.
Obtaining appropriate legal advice at the time that control of the family business passes from one generation to the next can ensure that there are no nasty surprises down the track for members of the retiring generation, who believe their days of having to worry about creditors of the business are over.
Be diligent in transferring a family business from one generation to the next
Succession planning and the transfer of a family business from one generation to the next is a process that needs to be undertaken methodically and comprehensively. Making sure you don’t leave any loose ends untied is the way to ensure that each generation carries responsibility for its own debts and misfortunes.
For more information, please see The vital importance of a business exit strategy.
