Lending to companies? Stay ahead of the queue
Posted 24 Apr 14
'Neither a lender or a borrower be' seems like good advice but is hardly realistic in the world of business. Nearly all businesses are financed with credit and most businesses will experience a cash crisis at sometime in their life. When they do, it is often the proprietors or their family who are called upon to tip in some money to help the business through.
So what should you do?
If you are willing and able to take the risk and help out there are some simple precautions you can take to stay ahead of the queue of creditors. These steps may also be used to stay up the queue when paying debts to avoid personal exposure from the ATO's Director Penalty Notices (DPN).
Advances made to a company specifically to pay wages, superannuation and employees' leave or termination entitlements (Payroll payments) can be repaid as a priority in an insolvency equal to that of employees' claims. Sometimes even ahead of secured creditors, depending on the type of security interest and the nature of the assets realised. This right arises from section 560 of the Corporations Act 2001.
To obtain the right, the practical steps that should be taken include:
- Have a written loan agreement expressly stating the advance(s) is to pay Payroll expenses,
- Register the loan on the Personal Property Securities Register (PPSR),
- The advance has to be paid to the company first and not directly to the employees, ATO or superannuation funds.
- Use a separate bank account (if possible) to transact the loan advance and the Payroll payments so that the transactions are not mixed with other funds and payments and are clearly identifiable in the company's records.
- If a separate bank account is not practical, then use the exact same amounts for the advances as the Payroll payments due and create an audit trail of notes and correspondence linking the advances to the Payroll payments.
- The advance(s) has to be actually used for the purpose of Payroll payments.
It is not sufficient for the lender to pay the Payroll payments direct. A recent NSW Supreme Court judgment held that payments made direct to employees by the lender could not obtain priority under section 560 or the ordinary rights of subrogation.
There are no time limits that affect the priority of advances made in this regard. A loan will maintain its priority ranking if it satisfies the requirements of section 560 and therefore its benefits ought to be considered whenever loans are advanced either for initial working capital or during a cash crisis. In some cases it may even be a more effective tool to obtain a priority ranking under section 560 than taking a registered security interest as these advances can rank ahead of claims by a secured creditor which relate to a circulating security interest. This means that distributions resulting from cash recovered, trade debtors or stock, may be payable to a party pursuant to a section 560 advance ahead of a secured creditor.
The priority limits for directors and their relatives for wages and superannuation to $2,000, and $1,500 for leave entitlements also apply to the priority afforded to a section 560 advance as no greater priority can be gained than would
have otherwise been available to the employee creditor.
The ATO's relatively new power to make directors personally liable (by a DPN) for unpaid Superannuation Guarantee Charges (SCG) and to 'lock down' that liability if it is more than three months old means the liability has to be paid either by the company or the director to extinguish the penalty. Given this, there may be distinct advantages in advancing the company money to pay such liabilities in a structured way to satisfy section 560, rather than the director paying the liability direct to the ATO.
Whenever structuring a loan to a company or dealing with a DPN for superannuation, section 560 should be considered. It may be the best and only way to stay ahead of the queue of creditors in an insolvency administration.
Contact our Business Recovery & Insolvency specialists if you have concerns about any of your business loan arrangements:
- Sydney - (02) 8346 6000
- Melbourne - (03) 9679 2222
- Newcastle - (02) 4962 2688