Protecting Shareholder Advances and Guarantees
All too often shareholders overlook the need to properly secure the advances they make to their company, or the guarantees they grant in favour of their company, without being aware of the consequences that can result from this oversight. By registering security over the assets of their company, shareholders can effectively and efficiently secure their advances to that company and feel assured that steps have been taken to safeguard their investment.
If you’re a business owner, you should endeavour to structure your affairs in a manner that reduces risk. As part of mitigating your risk, it’s important you understand that when you advance funds to your company, or grant guarantees for the benefit of your company, you’re just as entitled as any other creditor to take security.
No one starts a business with the mindset that it will fail and, in the normal course of business, shareholders shouldn’t need to call upon their security. However, circumstances change and if a company faces financial pressures or is put into liquidation or receivership, the shareholders may need to shift their focus to preserve their position ahead of the company and its creditors.
What is a shareholder advance?
Shareholder advances encapsulate all loans that a shareholder makes to their company. Whenever a company is incorporated, or a company requires more working capital, it’s likely that its shareholders will lend funds to the company, whether by way of a term loan or through a shareholder current account. Both of these methods of lending to the company are considered to be shareholder advances and should be secured against the assets of the company.
Why register a security?
As a shareholder, when you register a security with respect to your advances, you become a secured creditor of your company. By becoming a secured creditor, you will rank ahead of all the company’s unsecured creditors, increasing the likelihood that your shareholder advances will be repaid if the company becomes insolvent.
There’s nothing improper or immoral in you establishing a priority position in this manner. Other creditors have the right to search for shareholder security on the Personal Property Securities Register to determine who is ranked ahead of them. Creditors also have the right to demand security from a company or to rearrange the priority of various securities, before they sell goods to a company on an unsecured basis.
An additional and often overlooked benefit of securing shareholder advances is that by being a ‘secured’ creditor, you will have a greater degree of influence over liquidators and receivers – which is important at a time where shareholders and directors often have very little or no influence over their company.
Outside of the insolvency context, a well-drafted security agreement will also allow you to have recourse to the assets of the company in the event that a guarantee you enter into for the benefit of the company is enforced. Where you have given a shareholder guarantee to a creditor (usually a bank), it’s not uncommon for a creditor to call upon the shareholder guarantee without first taking action against the company if the company cannot immediately pay. This is particularly relevant where the creditor has recourse to property held by the shareholder. In this situation, it is important that if you’re the affected shareholder, you can legally and efficiently seek recourse against the company as compensation for your loss.
Preparing and registering a general security
Security for shareholder advances often takes the form of a general security over all of the company’s present and after acquired assets. This security is recorded in a general security agreement (GSA) that’s signed by the company.
The preparation of a GSA is relatively straightforward, meaning that the time and cost involved with instructing a lawyer or accountant to draft a GSA is insignificant when compared with the protection a GSA provides.
Once a GSA has been prepared, it’s essential that the security described in the GSA is registered on the Personal Property Securities Register (often referred to as the PPSR), which is administered by the New Zealand Companies Office. The PPSR is the register where details of security interests in personal property are registered and can be publically searched.
The timing of the registration of your security is very important. Generally, the order of registration determines the order of priority between secured creditors – so it’s critical to register your security as soon as possible.
Other practical considerations
Ideally shareholders should register their security arrangements before advancing funds to their company, no matter how healthy the business is at the time of the advance. Often shareholders only consider taking security when their company is already in financial difficulties. If the company is finding things tough financially and a shareholder registers a security should that company subsequently be placed into liquidation, the liquidator operating under the Companies Act 1993 regime will likely render the security taken by the shareholder as voidable. This means that the shareholder will end up being an unsecured creditor.
In addition to relying on shareholder advances, many companies will have borrowings with banks and lenders, which will often be secured by a GSA or other security arrangement in favour of the lender. It’s important that you check the provisions of the lender’s security before registering a shareholder security, as the terms of the lender’s security may prohibit the creation of further security interests without their consent. Consent from an external lender should be obtainable as long as they can be assured that the obligations owed to them are sufficiently secured. Some lenders may require a deed of priority in this situation to provide sufficient comfort that the shareholders’ security will rank behind the lender’s security.
Exit of a shareholder
In addition to securing shareholder advances, if you’re a shareholder in a multi-shareholder company, you should also turn your mind as to how shareholder advance/s will be repaid if another shareholder exits the company. Although many shareholders’ agreements address what will happen to a shareholder’s shares on exit, often no thought is given to repayment of shareholder advances. We recommended that shareholders get advice about the range of options available to cover repayment of shareholders’ advances, and releases of guarantees on exit.
In summary, for minimal cost and no matter how healthy the company is at the time you make a shareholder advance to your company or provide a guarantee, you should always secure that advance and/or guarantee by taking security over the assets of your company. By becoming a secured creditor, you can give yourself the best chance of protecting your investment and maintaining as much control as possible in the event of a liquidation.