Proper advice and business structuring is a form of insurance.

Many people are reluctant to turn their minds to the consequences if their businesses should fail, yet wouldn’t think twice about insuring their personal assets. Why? Both are unlikely to occur, yet there is always a risk.

A degree of preparedness for the possibility of business failure should feature in the short-, medium- and long-term financial plans of any individual with potential exposure to the liabilities of those businesses. This applies to sole proprietors, partners, and company directors. We believe it is vital they seek appropriate advice and take steps to protect their personal wealth in the event that their business fails. The consequences of failing to properly consider and guard against this risk (as well as a case of failing to manage business risk proactively) are evident in a recent Worrells matter.

We were the bankruptcy trustee of an individual who, along with his spouse, were directors of a company that owned and operated a newsagency in rural Victoria.

The business fell into arrears with the Australian Taxation Office (ATO). The ATO issued the bankrupt and his spouse with a Director Penalty Notice (DPN) for taxation liabilities exceeding $300,000. The directors took no action in response to the notice and, as a result, they became personally liable for their company’s tax debts. Had the bankrupt placed the company into liquidation or administration within 21 days of the notice’s date, they would have avoided personal liability.

The ATO filed a creditor’s petition against the director, but not his spouse. The director responded by filing for his own bankruptcy. At this time the ATO has not taken any action against the bankrupt’s spouse. However, given that she is also personally liable for the company’s tax debts, it is likely that the ATO will bankrupt her, or she will need to file for her own bankruptcy in the future.

The bankrupt had an interest in a range of assets, which now vest in his trustees including the family home, an investment property, a share portfolio and a term deposit. His spouse is a co-owner of those assets. Many, if not all, of these assets were the product of their efforts prior to becoming involved with the newsagency. In the end, the bankrupt’s assets will be dealt with through his bankruptcy and his spouse is likely to suffer the same fate.

The reality is the outcome could have been entirely different for the bankrupt and his spouse.

Firstly, had the bankrupt responded to the DPN by placing the company into liquidation, or voluntary administration, then he and his spouse would not be personally liable for the company’s tax liabilities. They had limited exposure to other company liabilities under personal guarantees and, therefore, it is likely that bankruptcy would be unnecessary.

Secondly, we understand the bankrupt’s spouse had no direct involvement with the company and, as far as we can tell, there was no good reason for her to be a company director. Had the spouse not been a director and was given sole ownership of the matrimonial assets, then it is improbable that her husband’s bankruptcy would put those assets at risk.

This example emphasises that business owners or anyone with potential exposure from a business failure (particularly company directors) need to proactively deal with issues like a DPN, and to consider the impact on their personal financial situation. In both cases above, investing in timely advice from accountants and solicitors may have resulted in considerable savings down the track. It cannot be stressed enough that it is usually too late to deal with these issues once financial problems arise.