When businesses hit the rocks

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Marcel Vaarzon-Morel outlines what can be done to avoid becoming a victim of a bankrupt business.

The recent story of the German boat company Bavaria Yachts and the appointment of administrators is not a new story. It finds its historical roots with the advent of the legal entity known as a ‘Company’ during the Industrial Revolution. The sole trader formation was viewed as too limited whereas the Company was viewed as an economic vehicle that would allow investment and business owner/operators to carry on large business transactions whilst being protected. Owner/
operators could become directors and stand behind what is known as ‘The Corporate Veil’ that (with some exceptions) provides protection from being personally sued.

In essence the corporate vision has not changed today, allowing investors to grow and reap the benefit of a profitable businesses floated on the stock market. These floated companies are not dissimilar to their cousins that are not floated, both providing protection to directors in the event that the company is unable to pay its debts as and when they fall due and possibly being forced into liquidation.

The reality for many small to medium businesses is that, given the size of transactions or their limited resources, they have little choice but to sell their services or goods to other manufacturers or suppliers on credit. There are several reasons for this but typically one is cash flow, as it allows for the end user to receive the product, with part of this final payment paying off the original service or goods account. In a perfect world this process works.

However, this simple explanation does not describe the complex web of variables that surround this type of transaction. It cannot be stressed enough how important it is to understand this web and to put in place processes and legal protections to protect a supplier of goods and services from possibly missing out on payment of their invoices… as the sorry tale below tells.

A harsh lesson

Prior to entering law, as an apprentice shipwright, I witnessed the harsh reality of a failing business. The Traditional Yacht (TY) saga is still remembered by marine businesses and trades people alike in Sydney, the Central Coast and especially on the Northern Beaches.

Approximately 35 years ago the business TY called in the administrators to manage their financial mess but it soon became apparent that there were too many creditors and too few dollars to go around. As an apprentice I was promised that my wages would be paid by the administrator, only to find out that the back pay owing up to their appointment would be payable as an unsecured creditor when the company was wound up. In fact, apart from the banks, every other creditor was unsecured resulting in very little being left over of the spoils that could be divided after the taxman, the administrator and banks had been paid. In those days superannuation was not compulsory so that debt was not on the list.

The stark reality of the collapse of the company ended in the director (Mike) copping some punches from which not even the corporate veil could protect him, with 10 prospective owners arriving at the factory to find only four boats remaining. As apprentices, we were all expected to work Saturday mornings (as ordered by the Apprenticeship Board, but that’s another story) and this was when I witnessed the chaos of owners fighting over the boats, rubbing off painted names and painting on their own names…. what a mess.

While months earlier I had had no idea that the business was going bust, strange decisions were being made such as being asked by Mike to remove the sail drive and cover the hole with cardboard then stick in the shaft drive engine. On the same day, the ‘owner’ would appear with Mike and, after they had left, I would be told to put the sail drive back in the boat. Soon the workers became suspicious but what could we do as, by this stage, sackings were pretty regular. Some of the creditors were stung so badly that Traditional Yachts single-handedly changed the face of boat building for the future with names like Peter Green Chandlery and others, well-known engine suppliers along with numerous tradesmen and apprentices receiving a couple of cents in the dollar.

So could the creditors have done things better to protect themselves? Put simply, the answer is ‘yes’ as the ability to have contracts that defined a fixed and floating charge were available. However, TY had a quick rise to fame and became known for producing well-built boats at a reasonable price of approximately $55,000. Businesses and creditors were swept along on the tide of success, throwing caution to the wind and apparently not considering whether the price was too cheap. And to add another layer of difficulty to this web, all the business people in this play knew each other and thus friendships and the ‘Gentleman’s Handshake’ were alive and well. Put simply, the boats were estimated by the administrator to be $15,000 underpriced so that, after several boats were finished, the deposits of the new boats were being used to finish existing boats.

Protecting yourself

There is no excuse today not to do your homework properly as there have been many simplifications made to assist business in this process and to help them protect themselves. Some options are:

  • Use a competent solicitor familiar with search engine and other investigative procedures to investigate the prospective business/manufacturer.

  • Whereas 35 years ago the internet didn’t exist, today the ease and ability to search online for credit checks, court records and cross referenced checks that include company and director searches is amazing and should be fully utilised.

  • If there is no written contract, get one. There is no room in today’s marketplace not to have a contract if you’re serious. And in fact, if a contract is not provided you should question the professionalism of the business.

  • Importantly, contracts should be in plain English and contain, amongst other clauses, a Personal Properties Securities Register (PPSR) clause. This property registration clause, if properly drafted, will allow the registration of an interest immediately that goods and services are provided. Provided there are not too many other registrations, it will place you high up the preference list, if not at the top.

  • A registration on the PPSR should occur immediately on supply.

  • Where possible a personal guarantee should be part of the contract. This binds the director personally to the debt and stops the director from hiding behind the corporate veil.

The unfortunate creditors of Traditional Yachts were caught by two main factors in allowing the depth of debt. The first was not having access to the searches of today. They relied on the goodwill and personal relationship that many had with Mike. The second, not having formal contracts in place, partly due to the personal relationships and gentleman’s handshake. Don’t let your business make the same mistakes, seek legal advice on how to avoid these traps.

About the author

Marcel Vaarzon-Morel of Vaarzon-Morel Solicitors was a shipwright of 18 years before becoming a lawyer and has had considerable experience in drafting contracts, debt recovery and bankruptcy proceedings. He can be contacted on 0439 495 988, email marcel@vmlegal.com.au or visit his website

This article was first published in the June-July 2018 issue of Marine Business magazine.

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