It is often important in corporate insolvency to consider the enforcement of director personal guarantees and the rights of creditors.
It is commonplace for directors of a company, particularly in the SME sector, to give a personal guarantee to persuade banks and other financial institutions to lend money to the company.
If the company is liquidated, directors can expect to have the guarantees enforced against them. The Corporations Act 2001 (Cth) is silent on this topic. Even the new legislation in 2021 that deals with simplified liquidations targeted directly at SMEs, does not alter creditors rights to enforce personal guarantees.
If a company is under a voluntary administration the law surrounding creditors rights and directors’ personal guarantees is quite different to liquidation. Section 440J of the Corporations Act provides that a creditor is required to obtain leave of the Court to enforce such guarantees and, generally, they will not be given permission to proceed.
The reasoning is that directors would be reluctant to appoint an Administrator if they would then be inviting the creditor holding a guarantee to proceed against them.
Section 440J is unusual in that it serves to protect the directors’ assets and not directly the company’s assets. The Court, when asked to grant leave by a creditor to be able to proceed against the guarantor, must be positively satisfied that there would be no prejudice to the voluntary administration.
At the conclusion of the voluntary administration, if creditors vote for a Deed of Company Arrangement (“DOCA”) proposal, the creditor holding a guarantee can take enforcement proceedings under the personal guarantee once the DOCA is executed.
A term in a DOCA drafted to obtain a release of the guarantee from the creditor will be unenforceable, unless the creditor in question specifically voted for the DOCA proposal.
If creditors vote for the company to enter liquidation, this also becomes the time when the creditor holding a guarantee can commence enforcement proceedings under the personal guarantee.
Under the new Small Business Restructuring legislation, directors (and their spouses and relatives) will have the same protections during the restructuring of a company as they currently have for voluntary administrations.
Under this new SME-targeted legislative provisions, the requirement to obtain leave to enforce personal guarantees begins on the date of the company’s appointment of the “small business restructuring practitioner” – and so follows similar lines to s. 440J.
But there are no changes in the Corporations Act to protect directors (and their spouses and relatives) who have given guarantees in the new ‘Simplified Liquidation’ process.