Suzie Leask: Welcome, everyone. Thank you for joining us at today's webcast on Tips for Protecting your Business. I'm Suzie Leask, Associate Director here at Australian Business Lawyers and Advisors and I'm joined by Special Counsel, Erin Brown. Hi, Erin.
Erin Brown: Hi, Suzie. Great to be here.
Suzie Leask: Just a couple of admin points before we get started and stuck in today's content, we do have a few resources and special offers for you to download, which you can do by clicking on the little blue arrow button at the top right of your screen.
Suzie Leask: Erin, we have been talking to a lot of businesses during the COVID-19 pandemic. It's really clear that businesses are certainly doing their best to just get on with it in some challenging circumstances. There's constant legislative changes to keep on top of, which I know is a full time job for us and as always, lots of business-related red tape.
Suzie Leask: In the first half of today's presentation, we're going to flag some of those key operational and regulatory compliance issues that you should be aware of and then we'll share with you some tips on how you can best protect and position your business and yourself for the future.
Suzie Leask: First up, we'll cover some key tips on business contracting during a global pandemic. I think so many businesses are having a much closer look at their contracts. It's such a fundamental part of making sure that you're as protected as possible while minimising risk and ensuring contracts are compliant and avoiding regulator scrutiny. As AGM season approaches and we continue to do business online, there are some important practical updates to ensure that you comply with the temporary changes, permitting virtual company meetings and electronic signing of documents.
Erin Brown: Next, we'll discuss what we like to call business prenups or shareholders agreements, which is becoming even more critical as we're seeing the pandemic put pressure on business relationships and businesses are looking to exit directors and shareholders restructure, sell or buy other shareholders, or even seek to introduce new investors or inject capital to secure the business's future. Finally, we'll run through some business succession and asset protection strategies and we'll share some tips for you there as well.
Erin Brown: We've had a number of questions submitted already, which is great. We'll answer as many of these as possible as we go on throughout the presentation but if you do want to submit questions, you'll see a little chat box at the top of the screen and feel free to ask as many questions as you need to as we go. If we run out of time, we'll endeavor to chat with you offline as well. One thing you'll see is that as we go, we've created a couple of polls so that you can reflect on how your business is tracking and where you might identify some gaps.
Suzie Leask: Okay, before we dive in today's content, we really wanted to acknowledge the fact that there are some businesses out there who are doing it tough and there's lots of directors and officers who might be a bit concerned about personal liability, particularly in the context of potential insolvent training.
Suzie Leask: Now, Erin, you're going to touch on personal asset protection later on and we are running a director masterclass half day training course, if director and officer liability is something that you're interested in learning more about but for today's purpose, it's really worth flagging that the government has recently announced some new insolvency laws in response to what's been described as an imminent wave of insolvencies, as many businesses we know are being propped up by those job caper wage subsidies and government support measures are coming to an end or being dialed back.
Suzie Leask: Currently, under new laws that were introduced in March in response to the pandemic, directors and officers have some protection from personal liability if trading while insolvent, but in only in certain circumstances. These extended safe harbour provisions only apply if a debt is incurred in the ordinary course of the company's business and that will mean different things for different companies during the now extended period from March to the 31st of December 2020 and before the appointment of an administrator or liquidator, but this is not a get out of jail free card. Directors still have to comply with their duties and as offices of care and due diligence, good faith, acting in the best interest of the company and so on.
Suzie Leask: Then, after that 31 December period, from the first of January, there'll be those significant insolvency law reforms that we have seen being introduced, which will affect small businesses with liabilities of less than $1 million. In short, it's going to introduce a new debt restructuring process and a liquidation pathway for small businesses that are affected and it's really important that businesses take advice early, stay on top of your financials, have your accountant and insolvency professionals if you need them on a speed dial and make sure you're hitting those procedural timing and technical requirements if you need to rely on those laws.
Erin Brown: Well, coming into business contracts and just before we start, we might run a quick poll. How confident are you that your business contracts are compliant and that your staff understand obligations under the Australian competition and consumer laws?
Suzie Leask: Just while we're waiting for those results to come through, I think one of the biggest trends I'm seeing businesses who are reviewing their contracts at the moment is that they're trying to learn from the issues that their staff are having with their customers or maybe some mistakes they've made in hindsight and learning from lessons from issues that arise and everything during the pandemic or where they say that regulators have prosecuted businesses for breach of competition laws, consumer protections rights to refunds or maybe they haven't been able to terminate or claim under an indemnity or other commercial terms. It's certainly a future facing and business protection approach in my experience, particularly with the regulators watching so closely.
Erin Brown: Yeah, it's something that we really need to be really careful with. From the results of the poll, it really looks like most of you have at least some concerns about the effectiveness of your current contracts or you're looking to update them. It's certainly worth getting on top of.
Suzie Leask: From a regulatory perspective, the ACCC is a very, very active regulator, plus they have a new COVID-19 Task Force. They're watching business very closely. They've publicly stated they expect businesses to treat consumers fairly during the COVID-19 pandemic. We've seen a particular focus around obligations to do with cancellations, refunds, suspensions of services as a result of COVID-19. We saw that in a big way in the airline and travel industry, where they put some pressure on the airlines to go back to affected consumers who had flight cancellations and clarify that they can elect to receive a refund for a canceled flight, even where they had previously accepted a flight credit. That's the power of this regulator. They've got that oversight where they can encourage businesses to take a best practice approach without even having to go to court.
Suzie Leask: I think it's really important not just to have compliant contracts at this time, but to make sure that businesses and their staff understand their contracts and they understand their Competition and Consumer Act obligations. This is where we're seeing people get a bit tripped up. Under the Act, can't mislead customers. That includes about what the customer might be entitled to under your business's terms and conditions or statutory consumer guarantees.
Suzie Leask: For example, rights to refunds, Freedom Furniture got in trouble for this recently. They paid penalties of $25,000 for a false and misleading statement on their website, which basically said, "You can't return or exchange items except at Freedom's absolute discretion." That's obviously misleading, because if you buy something that's faulty or defective, then you're going to be able to return those under your consumer guarantees. Really be careful that your staff are trained on Australian Consumer Laws and your contract terms because they're really getting caught by those statements in their dealings in emails and other discussions with customers.
Erin Brown: Yeah and I think it's important to recognise that it's not, if your contractors are up-to-date, that's not the only thing that you really need to be aware of.
Suzie Leask: Yeah, and from another perspective that I'm expecting to see some more case all around is the obligation to not act unconscionably when dealing with customers. I suspect we might see some arguments there where people are trying to retain significant amount of money under their cancellation or booking policies and there are arguments of significant hardship or special circumstances.
Suzie Leask: You also have to be careful not to get caught as a business with unfair contract terms. The regulator's watch that really closely and keeping in mind that this will apply to small businesses as well and particularly when they're dealing with small businesses and large businesses, so even business to business contracts. Just a reminder, unfair contract terms are often terms that create a significant imbalance where they're not reasonably necessary to protect legitimate business interests or they cause detriment if relied on.
Erin Brown: Look, Suzie, one of the questions we've had is about the difference between cancellation of contract and frustration of contract and how this really works in practice.
Suzie Leask: Yeah, frustration we'll talk about a little bit next, but the key difference is timing and the cause. If you cancel or you change your mind, obviously your cancellation policy or your contract applies and that's a bit different to a right to a refund, which is usually a statutory right like the defective furniture we were just talking about. Frustration is on the other end of the scale to change of mind. Where the parties can't perform their obligations because of some event outside of their control and lockdown is a great example of that but it's a very high bar. It's technical. It has to go to court to be decided, really and we'll go into that in a little bit more detail next.
Erin Brown: Yeah, look, another question that we've got here is when can I charge cancellation fees and how much can they be?
Suzie Leask: Yeah, this is a really tricky one because it depends so much on all the different variables, factors, specific circumstances and facts and your particular contract terms and cancellation policy. You also have to be careful that it's not due to a frustration event like the government orders or change in law. The really cancellation fee is talking about change of minds or preferences, in which case those contract terms apply. The timing and how close it is to the date of booking or the services might affect how much you can charge for the cancellation fee and whether you can mitigate your loss, say by offering the space or service to another customer.
Suzie Leask: Ideally, from a business perspective, you have a really well drafted cancellation clause or policy in place with the mechanism and the justification for those fees as much as you can. You can validly retain those business costs, while avoiding and this is the key bit unfair contract terms or penalty clauses, which might be unenforceable. Generally, if you are charging fees and admin charges, they should not be excessive and be limited to a reasonable cost associated with carrying out the cancellation.
Suzie Leask: The ACCC has made a number of recommendations as to how you can do this. This is really about communication and justification. Making sure you're telling them what they'll be charged, when they'll be charged the amount and identify the legal source of their right to the fee or retaining a certain amount or of a deposit. That's a really important part to get right to make sure you're not misleading those consumers about their rights. Often, we're also saying from a commercial perspective that itemized breakdown justifying the amount charged or retained and that's quite an effective negotiating tool and it's useful evidence, if it does go before a court later, that your retain costs were reasonable or even discounted.
Erin Brown: Look, another thing we're seeing a lot of is force majeure clauses and COVID-19 clauses and particularly in relation to force majeure they're in a lot of contracts and you've seen them in many contracts, but they really haven't come to light as much or as often as they have in the last six months.
Suzie Leask: Yeah, I think we've never reviewed many force majeure clauses in our lives and our careers, that's for sure but what is it? It's effectively a definition, right? A force majeure event is usually defined very broadly or specifically with a list of certain events, so extraordinary events, usually outside of control. Sometimes you see it referred to as an act of God or riots and now include pandemics and things like that.
Suzie Leask: When you're looking at your contracts from this perspective, really have a close look and see if they include a force majeure clause, which provides relief from non-performance or delay, check what falls within that force majeure definition that's relevant for your circumstances in your business. In some cases, of course, you might not want to force majeure clause and I think people are forgetting that these days. If I'm a business and I don't want a supplier to have an excuse for a delay and you're going to suffer damages, then I don't want to force majeure letting them get off the hook so easily.
Suzie Leask: Now, that's something different to frustration but usually, if you do have a force majeure clause, they're drafted to include a pathway as to what happens. Typically, you're relieved or you're discharged from your obligations to the extent you're unable to perform. You might be able to do part performance or you might be able to find a workaround, in which case it won't apply. Really be thinking about does this apply, are you actually unable to perform, and then look for a right to terminate and I find commercially, that's really important, if you don't want to be stuck indefinitely in a contract, particularly if you could get the suppliers or services elsewhere.
Suzie Leask: The other key trend we're seeing as an alternative is a specific COVID-19 clause and this actually deals with consequences of a COVID-19 event. It helps avoid frustration of contracts, which we'll talk about a bit more next. It's a contractual roadmap to deal specifically with further events of outbreaks, government orders, lockdowns, health advice, and so on.
Erin Brown: Suzie, what should businesses be doing in relation to their contracts?
Suzie Leask: I think it's just really important to get across your contracts. Review them and make sure you know what's in them, particularly to protect your business interest and your cash flow by having flexibility where you might need it to avoid ending up in breach or delay or certainty that a contract can't be easily terminated for force majeure or otherwise and plugging any holes or risk areas or potential liability that have sprung out during COVID whether by customers, suppliers, contractors, regulators, or otherwise.
Erin Brown: Given many contracts won't have particularly COVID-19 clauses in place, I think it's probably a really good time for people to be looking at their terms and conditions, their contracts and really taking this opportunity to make sure that they are watertight and working for them.
Suzie Leask: Absolutely. It's also to avoid the frustration of contract. What that is and we're seeing these terms thrown around a lot sort of by some late people who may not know exactly what you have to hit in order to meet the test of frustration, but it's a common law principle and it only relates to people of liability where the contract is impossible to perform or due to events beyond all parties' control. It's quite a high bar and importantly, the frustrating event has to be unforeseeable.
Suzie Leask: That's why we say if you put a COVID-19 clause in, clearly now going forward, that's not an unforeseeable event. It can't be caused by the fault of either party to the contract. It also can't just be merely inconvenient, difficult or more expensive to perform and just the same as force majeure clauses, if alternative arrangements can be made in order to perform the contract, then frustration won't be applicable. We're seeing that in a commercial and negotiated context where lots of people are avoiding frustration of contract issues by agreement because you can always agree to work around things. I think that's a very commercial approach to take.
Erin Brown: Yeah. Look, what happens if a contract is frustrated, do businesses have to give a refund in those circumstances?
Suzie Leask: This is the million dollar question.
Erin Brown: It is indeed.
Suzie Leask: Ideally, that would be great in various state of frustration of contract legislation will govern this. Again, depends a little bit on where you are, but generally, a frustrated contract is wholly discharged. There's no right to claim damages because no one's at fault. Under the New South Wales Act, for example, if money is partly paid before the performance of their obligation, then that money should be returned. This is absolutely at the moment something businesses want to avoid for cash flow purposes. Hence, though, is COVID-19 and force majeure clauses.
Erin Brown: Moving on to virtual AGM's board meetings and electronic execution of documents.
Suzie Leask: This is our new world, right? Everything's virtual, everything's online and yes, everyone's kind of getting on with this really important to be aware of those compliance and practical obligations as to how you do this in the new virtual world.
Suzie Leask: In March, this temporary legislation was introduced to permit virtual company meetings, electronic notices, and electronic signing of documents during the pandemic. Now, this is our new normal, but it's also not permitted under the Corporations Act or under People's Constitution. It's now been extended. It was six months. Now, it expires in March 2021 and conveniently, it applies to all types of entities and meetings, like board meetings, AGMs, and so on.
Suzie Leask: There's some specific governance requirements you still have to make in the usual manner but just now using different technology. This is the power, I guess, that lets you have those hybrid AGMs and board meetings. Though it says that meetings may be held using one or more technologies to enable member participation without being physically present, you still have to meet quorum but virtual participation is taken as being present for quorum purposes. You have to be able to ask questions through the technology and have some mechanism of voting, obviously, by poll, not show of hands if people are not physically in the room.
Suzie Leask: The notice is, I think, is the most complicated or technical part and company's secretaries are certainly finding that there's a lot to this. They're becoming a little bit IT support. It has to have, you notice, all of the information about the technology that you would need to participate, so information on how to participate, how to vote, how to speak and ask questions, and any other necessary information. We're also seeing people to give those notices in different ways. You might not have everybody's email address but people are sending a little postcard or a letter out to their members and with the information on how to log on online or where to find or download particular documents and proxies, of course, treat it the same way as if attending the meeting in person.
Suzie Leask: The other thing this legislation does is it allows the use of electronic signatures. We are, of course, doing a lot more business online, everyone's not necessarily in the office these days, and extends the definition of documents to cover execution of document in an electronic form. This is where we used to have a Section 127 Corporations Act, director and secretary sitting down were inking a document next to each other. Now, you can have one person physically sign and another person do an electronic signature of some kind and there's different ways to do that, whether you're pasting in a signature using DocuSign and so on but there's no need to sign the same physical document under these temporary legislation.
Erin Brown: Which I'm finding is really useful. I had a deal signed this morning where rather than having to have both directors sign the same execution clause, which can sometimes prove problematic even in non-COVID times we've actually been able to have individual pages for each director. That's really convenient and it means things can happen a lot more quickly as well.
Suzie Leask: I hope it stays, which I guess brings us to the main tip that I hope people will think about doing, if you find in virtual meetings are working for your organization, I think it would be a shame that this legislation gets repealed next year and then suddenly, you have to have an in person AGM next year to make some changes to your AGM in order to allow virtual meetings permanently on an ongoing basis. Really have a think about updating your constitution, particularly as we come into AGM season, you need that special resolution passed by members, usually, depending on your constitution and think about how you are placed going forward, so that you're not just governed by legislation that can change, make it work for you if that works for you.
Suzie Leask: The other tip is when you're running meetings and this is a real skill of chairs and company secretaries, to include everybody virtually and if you do have technology issues arise, keep those corporate governance principles in mind. Consider if someone drops off out of technology, whether that justifies an adjournment or a short break to make sure you still have quorum and participation and voting. It just avoids objections and procedural deficiency.
Erin Brown: Just making sure you take the time throughout the meeting to make sure that everybody's still connected.
Erin Brown: One of the other things just before we move off that topic is that the new legislation is also in place in relation to the witnessing of documents as well. What we're finding, Suzie, is that if you need a document witness, whether it's an agreement or a deed, whether it's a statutory declaration, a will, a power of attorney, we can actually do all of that online now. Rather than having to go into your lawyer's office and physically be present, I found that's convenient for a lot of reasons and obviously, due to COVID we need those requirements but it's also meaning that we can do those sort of meetings that are often a more personally nature, out of work hours.
Suzie Leask: Across the country as well. I'm loving that from a geographical perspective, I think, we have clients all over now and they can be signing documents at home, which is fantastic. Moving on to our business prenup topic and this is one of our favourites. We'll just run a quick poll on whether you have a current shareholder in place and most importantly how comfortable you are with its terms, because I think lots of people kind of have these agreements in their bottom drawer and they don't really know what's in them. Erin, I'm finding this is such a common issue at the moment and I don't know if that's just because business relationships are under pressure, because of lockdown, from financial pressures as well, or people are just reconsidering their plans for the future of their business and potential exit sales and bringing in investors as they grow or need injections of capital.
Erin Brown: Yeah, look, I think it's all of those reasons and just having a quick look at the results here, it seems that most of you either have an agreement in place, but are not quite sure of its terms or are looking to put one in place.
Suzie Leask: That's quite common, right? Many people say to us and we just haven't got around to it yet, because we know business owners are busy.
Erin Brown: Yeah, that's exactly right. In terms of shareholders agreement, well, COVID-19 is obviously changing the way that businesses are operating and that has become a real critical need for business owners to ensure that they have protected the future success of the business. The pandemic has really drawn out the need for a shareholders agreement. Often, there's businesses are in under a lot of financial pressure at the moment and we're seeing disputes sort of arise out of that, businesses looking for injections of new capital and they're also looking at new business opportunities and teaming up with new business partners to provide new products and new services.
Erin Brown: Setting up a new business is obviously a really exciting time but it can be a time that is as, Suzie said, is extremely busy and puts pressure on a lot of people. One of the things that we do find that people overlook and really getting those legal requirements, right, and making sure that they've got their shareholders agreement in place. Putting a shareholders agreement in place not only gives business owners the opportunity to ensure that they're all on the same page but it also sets the scene for how the relationship between shareholders and directors will develop over time.
Suzie Leask: I think in that start-up phase as well, perhaps when there's so many expenses and yet to make any money, I think people do put it off until later. I think that's a really important point, that it's not too late to put a shareholders agreement in place and it's something that should evolve with your business over the lifecycle as you're considering different things and changing it up and bringing new people on board or just revisiting the fact that you want to have something on paper that reflects what you're actually doing and how you want to run your business.
Erin Brown: Yeah, exactly. It's really, as Suzie said, it's a document that moves over time. Even if you have put that document in place at the start of your business, I'd always say every few years, you need to be pulling it out of the drawer and reviewing it, whether that's simply rating it or whether it's getting it updated, but making sure that it reflects the current nature of the business.
Suzie Leask: If its fit for purpose.
Erin Brown: Other than your spouse, your business partner is often the most important person in your life. Just like any other relationship, it's really critical to protect your investment in the relationship. In this sense, a shareholders agreement is really much like a business prenup by taking the time to discuss and agree how your business will be run, while all stakeholders are getting along and they're willing to make compromises. Disputes can easily be avoided. I usually look at a shareholders agreement as providing a roadmap for the lifecycle of the business, from start, middle, day-to-day operations, and then to the end when you're looking to exit. Not only can a shareholders agreement minimise conflict, but it can also maximise the opportunities for growth or ensure that shareholders are in a position to sell the business down the track.
Suzie Leask: I think that's probably why we like people to get it signed up when you're in the honeymoon period as well, because people, as you say, are more likely to agree it then later on when relationships are quite a bit more tense.
Erin Brown: Yeah, that's exactly right.
Suzie Leask: Okay, so let's talk disputes because I think shareholder disputes are quite a common theme at the moment and I find many business owners come to us, but only after a dispute is the reason and then we say, of course, what is your shareholders agreement say? It's the first thing we look at and often that answer is we don't have one or we did start putting one in place, but it just never got signed. For those businesses, I guess, who are trying to have those conversations and just, frankly, have other things to prioritise, why do they need to put that agreement in place?
Erin Brown: Look, it can be really frustrating, because I tend to find most common disputes can be easily avoided if an agreement was put in place or an issue dealt with at the start. We really see a critical need for shareholders agreements when business relationships start to sour and are at an end. The issues that I commonly see arise are really issues about, well, how is the business being run and particularly where a business has changed and developed over time, what might have been applicable at the start becomes less relevant as time goes on. Really, how is money spent and then how are those dividends paid and how shareholders are able to extract value from the business and that really common areas of dispute.
Erin Brown: The other one is where one party is looking to exit and that might be a natural progression of life or it may be that there is a dispute and they can no longer agree on the business but what I really find, sometimes they agreed that a party needs to exit, but when you stop talking price and what's a fair a price to pay, that can be really difficult conversation and having a shareholders agreement in place can really set out the parameters as to how that price has to be calculated.
Suzie Leask: Yeah, and I guess that's the thing, right? You want to have a roadmap in place for all those what if type circumstances so that later on, you don't get, excuse my language, but screwed over on price later on down the track because you don't have that mechanism in writing.
Erin Brown: Look, the other time I think it's really critical to make sure a shareholders agreement is in place is if you're looking at bringing on a new investor, so what you want to protect at that point in time is you don't want to suddenly lose control over the business that you've developed. You want to make sure that you've got provisions in place that protect the existing shareholders and make sure that they're not giving away rights that-
Suzie Leask: I had one client who told me that I don't want to get voted off my island...
Erin Brown: Yeah, that's exactly right.
Suzie Leask: ... which I think is exactly the point. That's often quite a scary thing for business owners to bring in a third party. This is their baby that they've created from scratch, they grow, and they put in the hard yards and I think that's a really good first question that we always ask clients, which is, do you really need to give them a piece of the pie, and if so, how big should that piece be and will their piece have the same rights as you?
Suzie Leask: People are generally way too quick, in my opinion, and experience to give away a stake in their company, particularly early on and believe me, it's so much harder to get rid of a director or shareholder than it is to appoint them and that's the case even when they haven't paid a cent for the shares.
Erin Brown: Look, there's so many ways you can incentivise people these days. You've got employee incentive plans, you've got share option schemes, you have bonuses when you can structure all sorts of arrangements. I think you've really got to be careful when you're thinking about do I want to give away something that I've grown over the years. What I'm seeing at the moment is particularly during COVID, I'm really seeing businesses looking at how do we raise further funds and how do we get further injections of capital? That might be to ensure the sustainability of the business. It might be because, as we said before, they're looking at diversifying but they're really looking at turning to investors to provide funding and that can be professional investors, it could be up and coming employees. It can also be business colleagues or friends who might run a different business with a different skill set.
Suzie Leask: I always find it's kind of useful to start with what you're trying to achieve and what you want to get out of the arrangement. Then, you align your document then your business contracts and your shareholders agreements or your incentive schemes to match that so everybody's aligned and incentivised to work towards the same thing but you're not losing too much control or too much of your ownership stake and financial interest as well. Like you say, absolutely, there's so many different ways to do that.
Erin Brown: Looking at it, is the investment that's being brought to the table worth a piece of the pie or is it something that is really a service that needs to be paid for?
Suzie Leask: Okay, talking about shareholders agreements, the devils in the detail, what should be in them?
Erin Brown: You'll often find when you're presented with a shareholders agreement, that they can be really long and technical but you can see some of the key issues that I dealt with on the slides in front of you. We usually use a checklist with clients as a prompt really of all the key commercial terms and factors that they need to consider make decisions on but it also provides an opportunity for a really great round table discussion where everyone can consider all of the issues that might arise over time and really think about, are we on the same page and are we able to agree on how this is going to work?
Suzie Leask: Yeah, and the reason we use that checklist, of course, is because no two businesses are the same. There's so many issues to consider. There's so many different ways to draft a shareholders agreement to get you where you want to go and to reflect your individual business relationships in your company and your different structures, of course.
Erin Brown: That's exactly right and looking at some of the things that you really need to consider when putting in place a shareholders agreement, I mean, they're all listed up there. I'm not going to go through all of them but look, how do you appoint directors? Is it up to shareholders to appoint directors who represent their interests on the board? Are we looking at putting independent third party directors who are really going to bring their skill set to the table and drive the business forward? Do particular shareholders get a right to appoint directors?
Suzie Leask: Director is a really important thing. I think a lot of people say, "Oh, well, I'm keeping my shareholding but we'll just put that person on our board," and your board controls your company. They're making the day-to-day management and oversight decisions. You have to be careful about your numbers, I think, both at a shareholder level, in terms of who's making what decisions, but who are you appointing on the board and what right or interest to us to retain in terms of the numbers game? Can you be outvoted?
Erin Brown: Yeah. That's exactly, one of the things you really need to think about is what decisions are for directors and what decisions do us, as shareholders, want to retain? Are there particularly critical business matters that need to go back to shareholders to make a decision on all that might require the unanimous consent and one of those is really, when you're spending a lot of capital on a new investment, do all shareholders have to agree on that?
Suzie Leask: Yeah, absolutely. There are some big ticket items. I mean, gosh, we have lists that they get tailored to that particular business as to what's a real issue for them, what might be of concern, what they might really just want to have a say on and keep their business close to their chairs.
Erin Brown: Really segregating those day-to-day operational issues from the more sort of critical shareholder issues that you see.
Suzie Leask: Let's talk about voting because voting, I think, kind of goes hand in hand with that and there's different ways to structure that in terms of who gets to say and on what issues in terms of different share classes and share rights.
Erin Brown: It's really critical to sit down at the start and look at, as you said before, does that piece of the pie have the same rights? Are we all able to vote equally on certain matters or are there certain shareholders that literally they're along for the ride? They are silent investors.
Suzie Leask: A silent partner, right?
Erin Brown: Exactly and what rights do they have? They might be people who are contributing capital at the start of the business, but really don't have any ongoing role in the business. Looking at how do you vote, does each shareholder have one vote or are we going to look at votes on a shares held basis? If you own 80% of the company-
Suzie Leask: It's weighted.
Erin Brown: Yeah, precisely, and that's a really valuable tool.
Suzie Leask: I do like a good veto, right?
Erin Brown: Yes. Particularly for majority shareholders, are there critical issues that you-
Suzie Leask: Or founding shareholders. That can be a neat way, I think, when you're bringing in those investors to have that final say kind of thing and you can do that at board level as well, which we talked about sometimes in a golden vote context.
Erin Brown: Yeah, that's really critical. Looking at dividends, how are they paid? Who makes that decision but more importantly discussing how often are we going to pay dividends and what kind of working capital do we need to retain each year to keep the business on track.
Suzie Leask: That's so important. I've had so many clients who are cranky at their other business partner because they just keep dragging down or drawing down some dividends from the company because they have this lifestyle to maintain and the other guy is like, "Can you please stop doing that." It's one of the things that's top of the list around expenditure over what certain amount of money do you need the other shareholder's approval.
Erin Brown: You'll also see that where there is differences particularly in age but also in where you've got a shareholder is looking to get out and retire down the track, and you tend to find that at that point, they're not as interested in investing in the business because they're looking at exiting. They're more interested in drawing profits where the young and up and coming shareholders who have got 20 more years to go tend to want to invest in the business a little bit more and it can be a really contentious issue if you haven't discussed it.
Suzie Leask: Yeah, absolutely. Then, that probably brings you to deadlock, right? If you are in that situation, how do you break a deadlock, particularly if you do have an even shareholding or to shareholders?
Erin Brown: Looking at, as Suzie mentioned before, do we give a particular shareholder a golden vote? Do we go back to shareholders and it sort of goes on percentages held or are we looking at really looking at those dispute mechanisms? Do we need to go to mediation or arbitration or is there a way that we can tailor this so that we don't end up in court?
Suzie Leask: I think you have to be careful there because sometimes you kind of go, "Well, that's a pretty good incentive for working out amongst yourself." If Your other option, your default option is, "Well, I'm going to give the decision about my company to a third party or the accountant or some random head of mediation at the Institute of Mediation and Arbitrators," or something like that. Ideally, obviously, if you can sort it out yourself, that's a much better outcome. Let's talk employee shareholders.
Erin Brown: Look, an employee shareholders always throw up a whole bunch of issues but in particular, what are we proposing when we bring an employee into the mix? Are there dividends in the company going to be tied to performance measures? If so, consider issuing them a different type of share, so that they haven't got the same class of share and we can clearly link their employment agreement into the shareholders agreement. Also, having a look at what happens when the employee exits the business, are they able to retain their shareholding as a silent investor or are they required at that point to actually sell their shares.
Suzie Leask: At what price?
Erin Brown: How then you do value that. Exactly.
Suzie Leask: I think that varies and that's what we talk about when we say bad labor provisions. If you've been terminated for misconduct, the price might go down or be subject to a certain percentage discount, as opposed to if you're a valued shareholder and you're allowed to keep those shares or sell them at market value. I think the employee point is such a good one because so often we say that they're not properly aligned and you can be terminated but suddenly, you're stuck with this guy who's still a shareholder in a company.
Erin Brown: That's quite, I find, Suzie, you obviously do too, is that often people will come and say, "Well, hang on a second, how do we get rid of him?" You haven't thought about that from wearing all of the hats it can create a problem.
Suzie Leask: You've got to pay them. Usually, the answer is how you get rid of those.
Erin Brown: You really need to make sure those documents are really working together.
Suzie Leask: Yeah. Also, from a non-compete perspective, if you have shareholders who are not employees, people are so used to having employment contracts with restraints in them, if you have a business owner who's not also an employee of the company, where's your restraint? What's stopping them from leaving and going and competing against you? That's something that I think shareholders with shareholder agreements can also deal with quite effectively.
Suzie Leask: The other thing from a dilution perspective is new share issues. If we were in business together, I wouldn't want you just going and issuing a whole bunch of new shares, which suddenly makes me a minority shareholder.
Erin Brown: No. You really just think about, well, how are new shares issued? Do we need to go to the existing shareholders? Conversely, what if I want to get out? How do I get out? Looking, I mean, I always find, Suzie, that the majority of the time there can be quite significant sale provisions in the shareholder's agreement and it's really a critical issue is, how do I get out? Do I sell to a third party or do I have to go back to my fellow shareholders and offer them a first right of refusal, for example.
Erin Brown: The other thing we really look at is what if we want to do a trade sale or an IPO and we want to sell the entire business? Are we able to drag along other shareholders? If we're founding shareholder or shareholder with the majority interests and we get a really great offer, can we force the other shareholders to sell?
Suzie Leask: Because those opportunities don't come around very often. You'd hate to be sort of stuck there with the rest of you shareholders and say I don't want to sell. I don't want to get bought out by some new big company.
Erin Brown: Conversely, looking at the alternative, which is if the founding shareholder or the majority shareholders are selling, can the minority shareholders force them to take them along with them, so that they don't end up in bed with somebody that they haven't met before or that they're not interested in being in business with. It's really important that those provisions are thought about at the start and then looking at default and termination, what happens if the relationship does sell out? What happens if we can't agree how this business is going to be run and what the next steps are? How do we get rid of shareholders who perhaps aren't behaving?
Erin Brown: We're looking at things like can we get rid of them as a shareholder? Can we seize their voting rights? For example, if we get rid of them, how much do we get rid of them for? Do they get full value or if they're potentially doing something that's jeopardising the business? Can we get rid of them at a discount?
Suzie Leask: That concept of what constitutes a default event and how bad the behaviour has to be is really, really important. Is it bringing the company into disrepute where you don't really want them associated with the business anymore? You want the right to buy them out but should that be subject to a little bit of a discount on the exit price because they shouldn't be rewarded for behaving badly or being fraudulent or doing something else that's a little bit dodgy.
Erin Brown: Yeah. There's quite a lot as you can see to think about. Look, it's really worth taking the time to get that right at the start.
Suzie Leask: Okay, let's move on to business succession planning and asset protection strategies. This part is all about protecting your hard work and investment in your business.
Erin Brown: Regardless of your business structure or business owners obviously take on some level of risk when operating their business but while some of this liability can be managed, either by ensuring you've got appropriate insurance policies in place or contractual arrangements that limit liability, you can't negate all risk. We've really got to look at putting in place asset protection at two levels.
Erin Brown: Firstly, you want asset protection at the business levels so that your business assets are protected but secondly, you really want asset protection of that personal level, so that your home, for example, is protected if there was ever a claim in relation to the business but by putting in place appropriate business structures at a business level and that might be operating your business through a company or through a trust. There can be a separation between your personal assets and your business assets. That means that liability for debts incurred in the course of carrying on the business or for negligence can be quarantined so that your personal assets are safe from attack by creditors.
Suzie Leask: This is something I've seen before come up. I'm thinking in particular around the building and construction industry, where I've had clients before who were unable to pay their suppliers due to nonpayment of their own invoices. That kind of money not coming down the line and so suddenly, they're in breach of their obligations to pay their debts. He was particularly worried because he was operating as a sole trader and he didn't want his home to be at risk. For those sort of businesses who are perhaps growing and they're not quite sure whether they want to spend the money, what would your tip be as to how to avoid that risk?
Erin Brown: That's a really great example, where operating your business through a company or trust can bring you some protection. Had that been the case, if the business was unable to meet its financial obligations, at worst case, it may have had to be wound up but at least the business owners' personal assets, such as their home would have been protected because there would have been that separation between business and personal assets.
Erin Brown: One thing you should be aware of is that it's not possible for business owners to eliminate all personal risk and that's particularly the case where they act as the director of a company. Generally, directors will not be personally liable for the debts of a company but it is common for directors to give personal guarantees in respect of company debts and directors can also be held personally liable for certain debts, either where there's been a breach of the director's duties in the Corporations Act or a common law or under specific legislation. Look, the World Health Safety and Occupational Health and Safety Legislation is a really good example of that.
Erin Brown: You can manage these personal liability, obviously, by undertaking asset protection measures at a personal level as well as at a business level. Those measures can be as simple as acquiring personal assets in the name of a non-risk spouse. Having your wife or husband acquire the family home, for example, if they're not at risk themselves or otherwise by establishing discretionary trust, so other suitable structures to then hold your personal and your investment assets.
Suzie Leask: I think that's a really interesting point. When you talk about personal level and business level, we're really meaning that you kind of have a box for your personal assets, your company and other things, and you have another structure for your personal assets.
Erin Brown: Yeah, that's exactly right.
Suzie Leask: That point about director liability, I think, is a really great one and that's where, as we know, director and officer insurance and director deeds of indemnity are really important where you want that contractual protection between you, the individual, and the company indemnifying the things that you do in the course of your directorship, also your officers as well, so CEOs, CFOs people who affect the financial standing of the company and come under that corporations that definition of officers.
Erin Brown: Yeah, that's one of the first things whenever I've been asked to sit on a board is do you have dates of indemnity and are you willing to put those in place?
Erin Brown: Having a quick look at business succession planning, which is really a critical element of the business lifecycle. Business succession can be planned, perhaps retirement or because a business owner is looking to sell and realise their investment or it could be unplanned, such as death or incapacity. While you often find that business owners make provision for planned exit events, they often fail to consider what might happen in circumstances where they're suddenly no longer able to run the business.
Erin Brown: The sudden death or incapacity even of a business owner can have catastrophic consequences but not only the business, but also the remaining business owners. Not only will it result in significant business interruption, but it could also result in a for sale of the business, if the remaining owners, for example, can afford to buy out the exiting owner shares or their estate or it could mean that the remaining business owners are effectively in bed with the deceased family or the deceased spouse, which can cause significant damage to the business and its reputation.
Suzie Leask: Yeah, and that's a really awful sort of scenario to be in, particularly where you're left suddenly putting in 100% of the effort, but only getting 50% of the dividend and conversely, we often find that I think business owners are they're good mates and they're close colleagues and so if something happens to one of them, they want to look after their business partner's family but you've got to have that mechanism in place to be able to afford to buy them out.
Erin Brown: Yeah, which can be really difficult, particularly where it's unexpected. Look, one thing that I always recommend to clients is that they enter into a buy-sell arrangement, and that is a document that really sets out exactly what's to happen if a triggering event were to occur.
Erin Brown: A triggering event could, as we've spoken about the death, it could be incapacity, it could be total and permanent disablement, that mean they can no longer work. I've even seen agreement refer to bankruptcy, if someone becomes bankrupt. What those documents do is enable the remaining business owners to purchase the outgoing business owner's share of the business, usually at an agreed price. Now, often that is market value, but I think you would have seen it before as well, Suz, sometimes where a particular business owner is critical to the business, you can reflect that in the documentation and I've seen discounts where, for example, the business would no longer be able to run in the same fashion where a particular party.
Suzie Leask: Yeah, absolutely. That price element is so important, because you want to be agreeing that as to what's fair, but what's not too onerous. How do you use the funding or the funding of those purchase prices and those payouts be managed?
Erin Brown: Yeah, look, it really depends on the stage of the business and where it's at but one of the first things that we usually look at is whether I would have found that through insurance, so through life insurance and trauma insurance. What that insurance can then be used to pay out the exiting business owner and transfer the shares. What you're looking at there is essentially, there's no transfer of funds between the business owners themselves, but the insurance really kicks in to pay out the exiting owner. That can be really useful. If it's not available, it's still really important to think about, well, how are we going to fund it? Are we going to do it over a period of time? For example, is there an upfront payment?
Suzie Leask: Instalment payments on an extended basis?
Erin Brown: Yeah and making sure that you don't want a situation where you're suddenly having to pay out a significant amount of money and that would otherwise have been used for the business operation?
Suzie Leask: Yeah, so you've got working capital left.
Erin Brown: Yeah. One thing I see is that, despite the critical nature of these agreements, we often find that many business owners, they don't plan for unforeseen circumstances.
Suzie Leask: It's a tough discussion to have, right what might happen.
Erin Brown: It is and it's very similar to estate planning and putting a will in place. People don't like to have those hard discussions. They don't want to think about it but the other reason is, it's always something when you're busy that can be dealt with tomorrow or next week. Look, not only kind of protect the future of the business, but it can also enable you to protect your family after you've spent years of hard work, sweat and tears. Most of my clients will say, "Well, I just want to make sure my partner is protected and my kids are protected." That is really important.
Suzie Leask: I think that helps you sleep at night as well. I know that I have a plan but I think a lot of business owners find that they like knowing that that's taken care of. Okay, a couple of things to be aware of. We've mentioned that there's a few resources you can download. We put together a bunch of special offers for you. There's a free guide to shareholders agreements, which you can access by clicking on the blue arrow button in the top right hand corner of your screen. For a limited time, there's a couple of fixed fee offers there, some around shareholders agreement if you're looking to update your documents or get new documents put in place. There's also a fixed fee on director offices dates of indemnity and some really great board and AGM pack. If you're looking to roll out a new induction pack for your board or you're just looking to update your corporate governance a little bit, make sure you check those out. I think there's like some 40, 50 plus pages worth of content there. Really have a look at those.
Suzie Leask: Upcoming training courses, if you're interested in hearing a little bit more about our director masterclass, director liability, and personal liability is such a big issue at the moment and a half day training as well on business contracts, which we're running in November and December. Of course, there's a huge COVID-19 hub and just other articles, guides, checklists and videos on our website. We might just do a quick check of question before we finish up.
Suzie Leask: One last question for you, Erin and we talked about it a little bit before in terms of structuring, what's the difference, I guess, between those trust structures and those company structures, which I can see someone sort of had a little question about, should I go a company or a trust? Is it really worth the effort?
Erin Brown: Yeah, look, my opinion is, in most circumstances, it is worth the effort. I mean, if you look at the cost of those structures on either an incorporation basis, but also an annual basis, it's really just an additional insurance policy.
Erin Brown: In terms of deciding what structure is best for you and which structure should you choose, there's a whole bunch of legal risks or asset protection, for example, flexibility going forward, but there's also the financial and taxation consequences. What you really want to make sure is does this work for me from a taxation and accounting perspective? Isn't going to provide me with the best structure for my particular business? It's really worth having your lawyer and your accountant or financial adviser work together just to make sure every person is different, every person's structure is different. Whilst, a company might be best for one particular business, a trust might be best for another.
Suzie Leask: I think that's probably why we work so closely with accountants when we're setting up these structures because everyone's personal circumstances and personal assets are so different. You might have multiple businesses, you might have family, money, and all sorts of other things to take into consideration that you lawyers don't know anything about. In my experience, I also find that the financial and the tax implications often are the drivers of the structures. Then, we build the legal framework around that, so to speak, and we can do the contractual protections, whether that's on a shareholders agreement or other incentive schemes and contractual arrangements basis.
Erin Brown: It will also depend on who you are in business with. If you're in business with your spouse, then you might be looking at a family discretionary trust, where all the beneficiaries can be related. Whereas, if you're looking at going into business with a third party, that sort of arrangement is not going to work for you because it's discretionary and you need to be on the same page. You might be looking at a unit trust or a company that will work better where there's multiple parties involved.
Suzie Leask: I think we've seen certainly the cost of getting that wrong is quite high, also from a tax minimisation perspective. We saw during the bushfires, of course, not-for-profits, with the wrong structure get really limited by what they could do under their constitution or the trust deed, as the case might be, where you can't actually do what you need to do with the money that you do a great job of fundraising.
Erin Brown: The other thing to consider there is it can be really costly getting it wrong, because of tax. To go from a sole trader or to go from a company to a trust, if you suddenly discover that you've got the wrong structure it can be expensive, because they're separate legal entities. You're transferring assets out. You're going to have stamp duty. You're going to potentially have capital gains. Look, I work with accountants all the time and there are definitely ways to minimise that. This will be small business concessions and all types of rollover relief, but they don't work for everybody. It's really about if you can get it right the first time, then you can go forth and you can worry about the business and know that you're doing that in a way in which you're protected and your family is protected.
Suzie Leask: Yeah. Fantastic. Thanks, Erin. I think we've pretty much captured most of those questions. If we haven't missed a question, do feel free to get in touch directly and we will certainly try and respond to all of your individual queries the best we can. Thank you for joining us today and we hope to see you again soon.
Erin Brown: Thank you.