Is it a business debt or personal debt, or both?

There is a lot of confusion about what is a business debt – partly because there is a real cross over between someone borrowing in a business or personal capacity.

 

To simplify it, we need to define what personal and business debts might be.

 

If an individual borrows money in their own name, for personal spending such as buying a TV, clothes, a car or a house in their own name, that is clearly a personal debt.

 

The borrower is liable without any ability to deny their responsibility for paying back that debt.

 

If they borrow money to establish, support or fund a business, for instance borrowing $25,000 from a bank to develop an e-commerce website to sell cosmetics, then that money is clearly being used for business purposes, but is still a personal debt.

 

However, a business can have several different structures that impacts on the personal liability of the owner or directors.

 

The main business structures in New Zealand are:

 

Self-employed or sole proprietor – someone trading in their personal capacity

A partnership – several people working together

A limited company – has its own legal personality.

 

What is my personal liability as a sole trader?

 

An individual is liable for business debts when they are self-employed and run their business in their own name.

 

If the business owner enters a hire purchase agreement to buy a vehicle it is a personal debt.

 

Also, if they sign a lease agreement for rent of commercial premises, they are personally liable.

 

What is my personal liability as a partner?

 

As a partner in a partnership business, you are automatically jointly and severally liable, that is, personally liable for all the debts of the partnership.

 

That means if one of your business partners becomes personally bankrupt, you and the other business partners are then liable for any and all the business debts of the partnership.

 

This can be historic, for example if a leaky home case is filed against an architectural partnership that designed the house but is no longer trading – then the partnership and the individual partners are still liable.

 

If one partner is insolvent, the solvent partners take full liability for the outcome of the leaky home hearing and the costs awarded to the building owner.

 

What is my personal liability as a director or shareholder?

 

Essentially, directors and shareholders cannot be naïve and think they are protected if their company goes bust.

 

There are lots of ways a director or shareholder can be liable for the debts of the company.

 

·       If a director or shareholder gives a personal guarantee in respect of the company’s debt, they become personally liable for that debt.

 

·       Directors and shareholders are liable if they allowed the business to trade fraudulently or recklessly, and they are found liable by a liquidator or the court for some or all of the company debts.

 

·       There is personal liability if the Inland Revenue proves that some of the debts of the company relate to trust funds that were inappropriately administered by the directors or shareholders.

 

·       If an overdrawn shareholder loan account accrues, it is then repayable by the shareholders as a loan to the company.

 

·       When drawings or dividends drawn are excessive it is much the same as taking a loan from the company and if the business goes bust – the directors will need to repay the funds.

 

·       The same goes for making excessive personal expense claims against a company, for example buying a fishing boat and claiming it as sponsorship or vehicles.

 

·       Also, if you have borrowed money in your own name and invested that money in the company by way of shareholder advances or share capital then you are still liable to the lender for that loan, even though you didn’t personally use the money – the business did.

 

 

Personal debt risks with guarantee liabilities

 

Guarantee debts normally arise where a director or shareholder has signed the following in their personal capacity, as well as director or shareholder:

 

·       Bank loans

·       Finance company loans

·       A property lease, even if that lease is subsequently assigned

·       A lease, finance or hire purchase agreement for plant, equipment or motor vehicles

·       A service agreement in respect say phone, computer or other services

·       An agreement with a trade supplier, which sometimes may not explicitly state that a director or shareholder may be personally liable, but may be as a signatory to the agreement

 

Depending on the nature of the guarantee, the creditor may also be secured by assets owned by the guarantor, a family trust or other person, and sometimes this again may not be clear in the terms and conditions.

 

As with any agreement, a person really must fully read the documentation presented to them so that they don’t inadvertently give a guarantee, when they had no intention of doing so. 

 

Taking legal advice before signing any documentation is therefore advisable.

 

Keeping track of your personal liabilities

 

One of the most common issues seen when businesspeople find themselves in trouble with debt, is that they don’t actually know what they might actually be liable for. 

 

Maintaining a list of any guarantees given is therefore advisable.

 

Getting into serious debt, or even considering bankruptcy, isn’t part of business owner’s plan.

 

With good financial literacy, advice and planning it can be avoided but should things get out of control it is stressful.

 

However, there are solutions and bankruptcy should be the last option rather than the first port of call for entrepreneurs.