Personal guarantees (PGs) are regularly sought to secure trade terms for company debt. Understanding the implications of PGs in the event of a company's failure is critical for both business owners and stakeholders.

1. Personal Guarantees Defined:

Personal guarantees represent a commitment by an individual, often a company director or shareholder, to take responsibility for a company's debts or obligations in case of default. These guarantees provide lenders with an added layer of security when extending credit to businesses.

2. Impact of a Failed Company and Personal Guarantees:

When a company fails, and it's unable to meet its financial obligations, the presence of personal guarantees ties the guarantor (often the director) to the debt. In such instances, the guarantor becomes personally liable for the outstanding debt (the balance the company does not pay), which could have significant financial and legal consequences.

3. Bankruptcy in New Zealand and Personal Guarantees:

In New Zealand, personal bankruptcy entails a legal process where an individual unable to pay debts is declared insolvent. Personal guarantees can exacerbate the situation for guarantors. In such cases, creditors can pursue the guarantor's personal assets (following a Court judgment) to recover the outstanding debt and failing payment, can opt to issue a bankruptcy notice and following that bankruptcy proceedings.

4. Legal Ramifications:

The consequences of personal guarantees in bankruptcy can include:
• Credit Rating Impact: Bankruptcy resulting from personal guarantees can significantly impact the guarantor's credit score, affecting their ability to secure credit in the future.

• Legal Proceedings: Guarantors may face legal actions to enforce the personal guarantee, leading to additional costs and stress.

• Bankruptcy: Guarantors may face a bankruptcy notice and then a legal proceeding and potential adjudication as bankrupt if the debt is not settled or paid

5. Mitigating the Risks and Seeking Advice:

Given the weighty implications of personal guarantees in case of company failure, individuals considering signing such agreements should proceed cautiously. Seeking legal advice before committing to personal guarantees is crucial to understanding the extent of liability and potential risks involved.

6. Alternative Risk Mitigation Strategies:

Exploring alternative risk mitigation strategies, such as limited liability structures, insurance options, or negotiating for limited or conditional guarantees, can help minimize personal exposure in case of company insolvency.

In conclusion, personal guarantees in the context of company failures carry substantial ramifications for guarantors. Directors and individuals should carefully evaluate the potential risks before committing to personal guarantees, seeking legal advice to fully comprehend the extent of liability and exploring alternative risk management strategies to safeguard personal assets. Being well-informed and proactive can significantly mitigate the financial and legal impacts of personal guarantees in times of business distress.

If you are facing pursuit of many company debts that you have personally guaranteed, an option is to reach informal settlements but care needs to be taken to not give preference.  An option is to consider a Part 5 Subpart 2 proposal under the Insolvency Act 2006. To discuss your options contact MVP team.

In the words of Fredrick Nael: “It takes both sides to build a bridge.”

An Alternative to Bankruptcy – Part 5 Subpart 2 Proposals

Insolvent individuals are often unaware that there are alternatives to bankruptcy and what the impact of those alternative options will be, so they are ill equipped to make informed decisions.

This article focuses on Part 5 Subpart 2 Proposals. There are other bankruptcy alternatives such as Debt repayment orders (DRO) formally known as the summary instalment orders (SIO) and no asset procedures (for debts less than $50,000) as well as informal settlements, none of which are discussed here.

Resolving personal insolvency issues using a Part 5 proposal requires the insolvent to put his/her best foot forward and the creditors agreeing to a concession and giving their support to the insolvent. The trustee brings it all together.

Background to Proposals

A Part 5 proposal is an option for an insolvent individual facing the prospect of bankruptcy to settle his/her debts. It is an opportunity for a person with significant personal debts to reach an agreement to pay his/her creditors in full or part by making a lump sum payment or advancing a deferred payment plan. A proposal must be approved by a majority in number that represents 75% in value of those creditors who vote on the proposal.

Some insolvents have the support of many creditors but face one aggrieved creditor who refuses to accept anything other than immediate payment in full, has a grudge, and is keen to advance bankruptcy proceedings for the sake of it. When you are facing bankruptcy because of one problematic creditor, you may be able to bind that one creditor with the support of the requisite majority of other creditors. It is not all doom!

Part 5 Case Study – Professional Advisor

I recently completed a Part 5 proposal for a financial advisor who was facing bankruptcy. His personal insolvency arose from serious ill health, which led to a loss of focus on his business and on maintaining his personal assets. His creditors, however, knew that he had been blessed with a full recovery to health and that, by supporting his proposal, he could continue to work as a financial advisor, earn a good income in future, and pay creditors a contribution towards their outstanding debts.

The creditors agreed the best outcome was to support the proposal and accept something instead of getting nothing. The alternative in bankruptcy would have been the end of a career and no return to creditors. The insolvent was able to borrow funds from his employer (borrowed against his future income) and contribute a lump sum to his creditors. The proposal was dealt with in less than three months and is now at an end. The result was that the creditors received more than they otherwise would have in bankruptcy. It was a “win/win” for everyone.

When Should Proposals be Considered

Proposals are not a good option for every insolvent person. Proposals require a financial outlay to cover the costs of the Court application for approval of the proposal and to cover the trustee’s costs in preparing them. They also require the support of the majority of an insolvent’s creditors. Avoiding bankruptcy is a significant incentive to some insolvent individuals, including where the insolvent’s career is at risk and when the individual clearly wants to repay what he/she can to his/her creditors in good faith.

Advancing Part 5 Subpart 2 Proposals

There must be advantages for both the insolvent and his/her creditors in a proposal arrangement or it will be a waste of time putting the proposal forward. A proposal must provide a better return to creditor than they would receive in bankruptcy.

The Advantages, in General Terms, of a Part 5 Proposal for the Insolvent are:

• avoiding the stigma of bankruptcy, the impact on your reputation, and the impact on family;
• avoiding the cost of defending bankruptcy proceedings;
• avoiding publicity of the insolvent’s insolvency (a proposal is between the insolvent and his/her creditors only);
• except in a few situations, property acquired after the filing of the proposal is not affected by the proposal;
• avoiding the restrictions faced by undischarged bankrupts, such as being required to provide information to the Official Assignee (“OA”) if changing address or job, not being able to leave New Zealand permanently without Court approval, or requiring a case managers’ approval to leave New Zealand for short time periods (personal or business);
• examinations of the insolvent are seldom conducted by the trustee; and
• the ability to be a company director and hold a management position in a family business.

The Advantages, in General Terms, of a Part 5 Proposal for Creditors are:

• avoiding the cost of Court proceedings;
• receiving a distribution from contributions made by third parties that would not be available to creditors in bankruptcy;
• receiving a greater recovery than what would be available in bankruptcy.

What Does the Insolvent Offer to his/her Creditors?

The proposed distribution to creditors usually comes from:

• funds advanced by family and friends;
• assets that would not be available to creditors in bankruptcy, for example, Kiwisaver entitlements (if approved), trust assets, assets subject to relationship property claims, funds borrowed specifically for distribution under the proposal
• contributions from future income to be paid over a period of up to five years rather than the normal three years;
• offering any windfall received for the duration of the proposal.

The insolvent’s family, friends, and related party creditors (who would be entitled to prove in the insolvent’s bankruptcy) can agree to subordinate their claims and not prove for their debts in the Part 5 proposal, which increases the return to the insolvent’s remaining creditors.

The Basic Rules when Seeking to Secure a Part 5 Proposal:

(i) Certainty of Return - creditors want certainty of a dividend. The creditor wants to know how much money they will receive as a dividend and when these dividends will be paid.
(ii) Certainty of Costs - the trustee’s costs need to be disclosed to creditors.
(iii) Disclosure - the insolvent must convince his/her creditors that he/she has disclosed all assets and interests.
(iv) Dollar Test - the insolvent must demonstrate that he or she has contributed the maximum that he or she can realistically contribute to the Proposal.

Is a Part 5 Proposal the Right Choice for You?

Bankruptcy can be the best option for an insolvent who has no ability to pay his/her debts and whose ability to provide for himself/herself and his/her family is not dependent on avoiding bankruptcy. For others, it is simply not feasible to offer a proposal.

Whether a Proposal is the right choice for you depends on:

• your ability to fund a proposal;
• whether you have the support of the requisite majority of your creditors;
• your ability to offer a sum to creditors that is more than they would receive in bankruptcy;
• your profession and your ability to secure future employment;
• the impact of bankruptcy on your employment; and
• the impact of the stigma of bankruptcy on you and your family.

In addition to any personal reasons, there are legal and practical reasons an insolvent may want to avoid bankruptcy:

• a bankrupt is obliged to attend any meeting that the OA requires him/her to attend;
• the OA can apply to have the bankrupt examined under oath;
• a bankrupt must immediately notify the OA of any change of name or address;
• a bankrupt must deliver to the OA all documents and papers in his/her possession that might relate to any of his/her assets, dealings, transactions, property, and/or affairs;
• bankrupts who practice in certain professions (for example: solicitors, financial advisors, real estate agents, and chartered accountants) cannot act as principals or hold the positon of director;
• bankrupts who have an income surplus after living expenses may be required to contribute that surplus towards payment of their debts;
• self-employment is not often an option (there are some exceptions);
• a bankrupt cannot act as a director of a company during his/her bankruptcy (there are some exceptions);
• the OA may investigate the financial affairs of an associated entity (company, partnership, person, or trust) of the bankrupt so far as they appear to be relevant to the bankrupt or to any of his/her conduct, dealings, transactions, property and affairs;
• the bankrupt’s bankruptcy must be disclosed to anyone to from whom the bankrupt applies for credit of $1,000 or more;
• transactions, gifts, or settlements that took place in the five years before the bankrupt’s bankruptcy will be examined;
• some employers require employees to disclose whether they are or have been bankrupt as do insurance companies; and
• the impact of the bankruptcy on the family home (this is a complex issue that will need to be considered by the insolvent before becoming a bankrupt).

I will end as I started. Dr Maya Angelou said: “You may not control all the events that happen to you, but you can decide not to be reduced by them.”