Don't let business debts put your family home in danger

Let’s say your business fell into debt it was unable to pay off. Would your property stay out of creditors’ hands? How about your car, even your savings?

Would you be able to keep your personal and business finances separate?

If you signed a personal guarantee to get a loan or supplies on credit, the answer could be no.

Personal guarantees are common in the business world nowadays, and no industry is immune to them.

In essence, these agreements legally bind their guarantor, usually a business owner or director, as liable for the debts of their business if it defaults on financial obligations.

Personal guarantees are often used to help secure business loans without a strong credit history and/or the right assets to offer as collateral. Suppliers or contractors might also request one for goods and services on credit.

But what happens if the business fails, your personal guarantee is activated, and you can’t honour the terms?

Director of restructuring and recovery at RSM in Canberra, Adam Cormack, says if a guarantor can’t pay off debt as promised or negotiate a commercial settlement, their personal assets might be seized to cover the cost.

“If a business defaults on its obligations, creditors with a personal guarantee have the right to pursue its guarantor individually,” Adam says.

“They could seek a court judgment debt or even pursue personal insolvency or bankruptcy. This would put property, vehicles, savings or investments at risk of sale to repay the amount owed.”

In short, your entire capital could be at risk.

Plenty of smart legal strategies out there help keep critical assets safe, but they should be organised well ahead of time.

“Asset protection is all about reducing your exposure to financial risk,” Adam says.

“A trusted business adviser can work with you to essentially quarantine personal assets from your business.

“But if the structures implemented aren’t adhered to properly, they could be unwound if the business fails.”

For example, advisers might suggest having property titles held by your spouse, family trust or self-managed super fund, instead of your own name.

It’s also worth remembering some business and company structures are better at limiting liability than others, so make sure you’re operating under the right one.

So, what happens if you sign a personal guarantee without asset protection and your family home ends up in the firing line?

“In some cases, your equity could be refinanced without giving up your spouse’s share of the home,” Adam says.

“This can be done using a doctrine of exoneration, but it only applies if the loan was secured using a joint asset. You’ll also need to demonstrate that you were the only one to benefit from the loan or credit facility.”

Essentially, a doctrine of exoneration means whoever benefitted from the loan (you) is responsible for repaying it, not the asset’s co-owner (your spouse).

If the application is successful, only your portion of the home’s equity can be used to consolidate the debt, generally leaving the rest protected.

RSM Australia’s national head of restructuring and recovery, Frank Lo Pilato, recommends avoiding personal guarantees altogether if you can.

“I do see some business owners signing unlimited guarantees without really considering the risk,” Frank says.

“You can reject the request, and in some cases, you probably should. At least try to negotiate for a limited agreement that caps your liability by a specific amount or percentage of the debt.

“It could mean you don’t get the loan or credit you’re seeking, but there are other ways to work towards your goals.”

Frank says communication and qualified support are key.

“Whatever you do, don’t cut off contact with creditors,” he says.

“Engaging a professional early is critical as we can negotiate on your behalf.

“Navigating debt is not something to do alone, so ask for help if you’re in trouble. It’s that simple.”

For more information, contact RSM in Canberra on 6217 0300 or visit RSM Australia.