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New Zealand is the home of small business. Each year thousands of businesses are started, and each year many businesses fail. Traditionally a person starting a business formed a company, put some assets or cash into the company, and borrowed money from a bank under the security of a debenture. The debenture was a charge over the whole undertaking of the business, and invariably the bank was covered.
There are now so many preferential creditors who rank ahead of the debenture that the security of a debenture holder has been watered down. Those standing in front of the bank are not only wage earners, but the Inland Revenue Department for GST and for PAYE. These latter amounts can be substantial. Because of this the banks, instead of a debenture, now commonly require as security personal guarantees from the shareholders and directors supported by a mortgage over the family home. The effect of this is that if the business fails the bank will call up its securities. The family home is therefore at risk and often has to be sold.
The attitude of the banks is perfectly understandable. In the early days of a company's life it has little in the way of assets and invariably the company from its own resources is not able to provide sufficient security for the banks purposes.
What is overlooked in this equation is the fact that by the time the company fails the assets of the company have built up and are greater than at the commencement. As well as physical assets there will be trade debtors which did not exist at commencement. This means that if from the outset there had been a debenture as well as a mortgage then the family home would not have been at risk. We have seen many cases where people have lost their home because of the mortgage held by the bank, whereas, if the bank had held a debenture as well as a mortgage the home would not have been at risk.
We strongly urge all advisors to companies that they should insist on their client's behalf that the banks as well as taking the personal guarantee and mortgage over the directors houses should also take a debenture over their companies. In most cases our experience has been that if this had happened the directors would be still living in their homes and their homes would not be sold from under them. In considering this, legal and accounting advisors should be aware that where the family home is lost then there is not only a loss of assets but invariably there is the emotional and personal cost of a broken relationship.
DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.