Introduction to Small Business Asset Protection
When starting a business—whether through social media, online, or in person—individuals often believe they must establish a corporate structure. They think this is necessary because “companies run businesses” and are drawn to the allure of the “corporate veil.” The corporate veil is a long-standing concept in business and law. It establishes a company that operates separately from its owners. This separation creates a barrier for asset protection between an individual and the business’s creditors. Many people rely on the corporate veil for business activities, assuming that if things go poorly, the company will end and they can restart. Unfortunately, this assumption is inaccurate today. Creditors’ and claimants’ rights have significantly increased, enabling many parties to challenge a person’s ability to run a business.
For effective small business asset protection, most small business agreements include some form of guarantee or indemnity. This typically involves a clause or separate document where the sole shareholder guarantees the company’s performance under the agreement. Many business owners do not blink before signing. To complete the deal, business owners often sign guarantees. They believe it won’t go wrong and that they won’t need to honor the guarantee.
Guarantees and Indemnities: Hidden Traps in Small Business Asset Protection
When it does, however, the matter can go very poorly. The recent decision of the NSW Supreme Court in Smart Dollars Tamworth Pty Ltd v Corpique No.18 Pty Ltd [2024] NSWSC 1211 is an example. In that case, the court ordered the sole director of a company to pay over $2 million in damages. His company had breached the lease multiple times and abandoned the premises covered by the lease. The landlord used the lease guarantee provisions to seek full payment for damages from the director personally due to tenant breaches.
Similarly, a small business owner could become deeply indebted to their bank for obligations under a loan or bank guarantee if the company fails to perform. While operating a business offers substantial benefits, owners must understand their obligations. They should keep business funds separate, meet creditors’ demands, and ensure the business trades solvently. If a company lacks the necessary funds to meet its creditors, it may be trading insolvently. In this case, the director breaches their duties. They may need to repay the company to satisfy creditor claims.
Another area where the corporate veil fails to offer the protection that individuals might hope it does is in the case of relationship breakdown and property adjustment. The Family Law Act provides significant discretionary powers to adjust property interests in the event of relationship breakdown. That includes the value of businesses owned and operated by interested parties. In those cases, orders can require third parties to adjust interests and make payments, even if they weren’t directly involved.
Conclusion
If you require advice about understanding the risks of different business structures, advice about asset protection when operating a small business, or advice generally about your obligations when running a small business, contact us here.
