What you need to know
Unless you’re a retail store, you can’t run a small business without incurring debtors. So it’s important that you understand the different type of debtors you might find yourself coming into contact with.
Why? Actually, it’s an important detail for credit providers and debt collectors to know, because the legal obligations and process for payment is different based on the different types of debtors.
So here’s your quick guide to the different types of debtors there are:
Individuals:
If you’re an individual debtor, then this means you have entered into a debt on your own behalf, not for the business you own. An individual debtor is a pretty straight forward concept, basically you are solely responsible for your debt, and you may have to use your personal assets as security on the loan.
And just in case you were wondering, if you marry someone who is an individual debtor, that debt legally does not automatically become yours! This only happens if the legal status of the debt is ‘joint debtor’. But if you buy a house together, then that asset can be seized in order to have the outstanding debt paid.
Joint Debtors:
Essentially a joint debtor is where two or more people enter into a debt arrangement. The biggest thing to know about joint debtors, is that you cannot “split” the debt – there is no debt sharing legally. Both (or all) of you are still liable as individuals for the whole debt if the other party(ies) won’t/can’t pay. Then it’s up to you to seek recompense via the legal system.
Let’s break that down into an example for you: let’s say you and a friend enter into a contract as a joint debtor. You have personally agreed to split the repayment between the two of you but then one day your friend becomes unemployed. Unfortunately your friend can no longer pay off their share of the debt, even though you have paid off your share. All good right? Wrong. The creditor is now seeking out you to pay the rest of the debt off, and legally you are responsible to do so.
Guarantor:
A guarantor on the other hand is not legally required to repay a debt until the debtor has defaulted. When the debtor is in default, then the creditor can take the same legal action against the guarantor as they would do with the original debtor. Typically, a guarantor is restricted to immediate family members who provide additional security to a loan.
Sole Trader:
Many of you reading this will probably fall under this category because you operate a business under the banner of a sole trader. A sole trader is legally the same entity as their business. This means that your business does not have separate assets and separate debts, your businesses assets and debts are your assets and debts. So unfortunately this means that your business has unlimited liability, meaning that there is no limit for how much you are liable for your businesses debts.
Partnerships:
Similar to sole traders, partnerships, where a number of people come together to run a business, have unlimited liability. However there is an exception to the rule! A silent partner, is one who usually has limited liability, only up to the amount they invested. This is the case because, as the name implies, these partners are silent, and generally do not have a say in business decisions.
Companies:
A company differs from sole traders and partnerships, as they’re legal entities in their own right (and separate from their owners) and hence have limited liability.
If it’s a public company, the shareholders’ personal liability is only limited to the total value of their shares. If you own the company, you’re limited to a legal suit to the total of the business’ assets.
UNLESS, you owe a tax debt (as a director) or you have defaulted on your employees superannuation payments – then as a director you’re up for the lot. Best not to do either of those things – and the government ALWAYS gets paid.
If a business that owes you money, goes belly-up, then you will be on a creditor list that ‘may’ get paid at some point – maybe, but probably not as much as you’re actually owed (that’s what provision for bad debts is all about).
So you can see why it’s important to know the differences – especially if you’re in business, contemplating starting a business or changing your business structure.
And if you are contemplating restructuring your business or entering into a debtor agreement, business loan, or becoming a guarantor you should seek professional advice before committing to anything.
If we can help, we’d be delighted to talk to you! You can call Kerry on 6023 1700, drop us a note or connect with Kerry via LinkedIn.
