When keeping it in the family becomes detrimental.
Family-owned and run businesses are common. Finding good employees requires a strong level of faith and assessment of the person’s strengths and attributes. Who better than family members who you’ve known most of your life? People will also naturally want to share their success and wealth with those that they love and care for. Employing family members is also great for succession planning to allow young adults to learn and eventually inherit their parent’s business. Things will often work perfectly fine during times of prosperity. However, what we often find is that people forget or don’t realise that when a company encounters financial issues and is placed into liquidation, their position can be far more detrimental in comparison. This article gives some examples we encounter—almost daily:
- Ineligible for FEG
- Limited priority
- Inadequate qualifications
- Director duties and liabilities
Ineligible for FEG
Many readers will be familiar with the government’s Fair Entitlements Guarantee (FEG) scheme that seeks to ensure employees of insolvent entities are paid most, if not all, of their outstanding entitlements. However, directors and their relatives are excluded from the scheme. Rightly so given the knowledge, relationship and benefits that a related employee often receives prior to the liquidation and the ability of those employees to take advantage of the scheme if they were eligible.
Recently we encountered a situation where an employee worked for her sister’s company for over 10 years. She did not appear to receive additional benefits or special treatment from her relationship to the director/owner. She had been paid a market salary and could have found a similar job with an unrelated employer on the same terms. Following the insolvency of her sister’s company, she was ineligible for the FEG scheme, which included long service leave and redundancy payments that she would have received under the scheme if she had undertaken a similar role at an unrelated employer.
The Corporations Act 2001 provides that when a dividend is available in a liquidation, employees have a priority status in being paid from that dividend before other unsecured creditors. However, the priority for director’s relatives is limited to $2,000 for wages and superannuation and $1,500 for leave entitlements. Any outstanding employee entitlement above these limits will rank as ordinary non-priority unsecured creditor claims in a liquidation.
In the situation above, we eventually recovered enough funds to pay a dividend to priority employee creditors. The related employee’s claim was limited to the above amounts and again missed out on a material payment of her entitlements due to her family relationship.
Frequently we see cases of family members brought into roles that they’re obviously unqualified for. Incredibly, most of the time it’s the company’s financial controller/accountant role. And all too often, the company’s failure can be directly attributed to the poor financial control and record keeping by employees who were completely unsuitable and unqualified for those roles.
Duties and liabilities as directors
Family members are often appointed as joint directors for simple reasons such as imparting some ownership and responsibility or for the pure status of the title. However, increasing the number of directors only increases the risk and exposure to breaches of directors’ duties and insolvent trading claims. When there is no genuine function or benefit, families should consider whether there is a need for multiple directors in a small company. Conversely, a frequent presence and participation at important meetings and decisions (when not a registered director) can support claims of shadow directorship and expose them to potential claims.
Lastly, we’ve seen a plethora of once close family relationships break down because of insolvency and financial issues. We’ve seen siblings falling out over uncertainties over responsibility, performance issues and disciplinary actions. We’ve seen families argue over the business direction and commercial decisions. We’ve seen entire family clans form divisions over financial losses experienced by family businesses and individuals. Again, wanting to give and share successes with people we care for is admirable, but everyone involved must be highly cognizant of the real possibility of a breakdown of that very relationship.
There are many reasons to employ and be employed by family. We are certainly not saying that family should never work together or for each other. However, business is inherently risky. We would hope that those who do find themselves employing or being employed by family are aware of the potential issues, know the reasons for entering those arrangements, and are better informed to take those calculated risks.