There is a lot of confusion about what is a business debt – partly because there is a real cross over between someone borrowing in a business or personal capacity.
To simplify it, we need to define what personal and business debts might be.
If an individual borrows money in their own name, for personal spending such as buying a TV, clothes, a car or a house in their own name, that is clearly a personal debt.
The borrower is liable without any ability to deny their responsibility for paying back that debt.
If they borrow money to establish, support or fund a business, for instance borrowing $25,000 from a bank to develop an e-commerce website to sell cosmetics, then that money is clearly being used for business purposes, but is still a personal debt.
However, a business can have several different structures that impacts on the personal liability of the owner or directors.
The main business structures in New Zealand are:
Self-employed or sole proprietor – someone trading in their personal capacity
A partnership – several people working together
A limited company – has its own legal personality.
What is my personal liability as a sole trader?
An individual is liable for business debts when they are self-employed and run their business in their own name.
If the business owner enters a hire purchase agreement to buy a vehicle it is a personal debt.
Also, if they sign a lease agreement for rent of commercial premises, they are personally liable.
What is my personal liability as a partner?
As a partner in a partnership business, you are automatically jointly and severally liable, that is, personally liable for all the debts of the partnership.
That means if one of your business partners becomes personally bankrupt, you and the other business partners are then liable for any and all the business debts of the partnership.
This can be historic, for example if a leaky home case is filed against an architectural partnership that designed the house but is no longer trading – then the partnership and the individual partners are still liable.
If one partner is insolvent, the solvent partners take full liability for the outcome of the leaky home hearing and the costs awarded to the building owner.
What is my personal liability as a director or shareholder?
Essentially, directors and shareholders cannot be naïve and think they are protected if their company goes bust.
There are lots of ways a director or shareholder can be liable for the debts of the company.
Personal debt risks with guarantee liabilities
Guarantee debts normally arise where a director or shareholder has signed the following in their personal capacity, as well as director or shareholder:
Depending on the nature of the guarantee, the creditor may also be secured by assets owned by the guarantor, a family trust or other person, and sometimes this again may not be clear in the terms and conditions.
As with any agreement, a person really must fully read the documentation presented to them so that they don’t inadvertently give a guarantee, when they had no intention of doing so.
Taking legal advice before signing any documentation is therefore advisable.
Keeping track of your personal liabilities
One of the most common issues seen when businesspeople find themselves in trouble with debt, is that they don’t actually know what they might actually be liable for.
Maintaining a list of any guarantees given is therefore advisable.
Getting into serious debt, or even considering bankruptcy, isn’t part of business owner’s plan.
With good financial literacy, advice and planning it can be avoided but should things get out of control it is stressful.
However, there are solutions and bankruptcy should be the last option rather than the first port of call for entrepreneurs.