Undoing the benefits of asset protection.
A well-known branded business was a respected, local icon that employed hundreds over the business’s 60-year life, and was a second generation business. Its structure was a common legal structure: an asset holding company (company A) retaining the commercial buildings, and a separate company (company B) responsible for the trading of the business. This structure provided sufficient asset protection to company A from any event company B faces.
What didn’t change over company B’s business life was the business model, the internal processes, the resources, and management. And was blissfully unaware that its business partners, competitors, and other business were evolving to align with modernised business practices.
When the industry started to feel the effects of a downturn combined with increased local competition, the lack of controls and poor management over a two-year period resulted in large trading losses. These consecutive year trading losses were sufficient to sink most businesses.
…And yet, remarkably, not this business. How did it sustain such large losses?
Company A had valuable assets in the form of equity generated in the commercial properties, however, these assets were about to be eroded at an accelerated pace!
To fund these trading losses, company B sought an overdraft facility, which was granted on the condition that company A’s commercial properties were offered as additional security. Furthermore, the banks increase in credit to the business came at a cost in the form of higher interest rates. In summary, to fund the trading losses of company B, company A offers up what were previously protected assets. Company B continued to incur further trading losses that ultimately exhausted the overdraft facility. As a result, the bank withdrew their lending support and called upon all debts to be repaid.
Without the bank’s support, business survival was impossible and the director was left with no alternative other than to place company B into voluntary administration.
As administrators, Worrells considered the viability of a Deed of Company Arrangement to determine if this long-standing business could survive. Unfortunately, it was too late as:
- The company’s working capital was solely reliant on the bank’s overdraft facility, which was fully drawn.
- Unsecured creditors’ debt was at an all time high.
As an aside, the director was exposed, personally, due to the numerous personal guarantees he had provided.
If the director had been more proactive and sought appropriate advice prior to obtaining the overdraft facility, the outcome may have been different.
Had the business doors been closed two years prior company A’s assets would have been retained with sale proceeds in excess of $1.5 million in the bank! Meaning company B would not have required company A’s assets to extinguish its debts.
What lessons can be learnt?
- Don’t just assume business will survive because of a 60-year history.
- Don’t expect a failing business to improve, if you’re not willing to innovate or evolve.
- Don’t fund losses with borrowings.
- Don’t wait too long to seek proper advice.
While the director’s intentions were to keep the business propped up, by drawing upon assets held under another entity, inadvertently its clear asset protection purpose was undermined in the process. All too often, we see the benefits of a good, solid company structure being undone in moments of high stress and without proper review and advice.