Why Businesses Need to Document In House Arrangements

From the day you set up a business, you must think about two things, limiting your liability if things go wrong and protecting your assets. 

As part of a risk management and asset protection strategy, we recommend you separate your business risk from your assets and conduct your business through a dual-entity structure, where one entity, say your proprietary limited company operates the business (the Operating Entity), and another entity, perhaps a trust, self-managed super fund, and/or another company, owns the business assets (the Asset Owning Entity).  The Asset Owning Entity then makes the assets available to the Operating Entity under a ‘lease’, ‘licence’ and/or ‘loan’.

This structure allows your Operating Entity to use the assets in your business, but if the business fails with debts owing to creditors, the assets used in the business will not be available to satisfy those debts, since they are owned by another legal entity (i.e. the Asset Owning Entity).

There are two very important steps that must be carried out which both involve paperwork:

Step one

Have formal lease/licence/loan agreements between your entities.

For this ‘business asset protection’ strategy to work, you need a formal agreement between your two entities, whereby the Asset Owning Entity provides the Operating Entity with the use of the business assets.  These agreements record the fact that the assets remain owned by the Asset Owning Entity and are only available to be ‘used‘ by the Operating Entity.

Businesses should never skimp on the paperwork. Do not try and re-use old agreements as ‘precedents’ or attempt to ‘simplify’ the documenting of these arrangements.  This is where you get value from having proper legal advice.  These agreements must clearly record the assets involved and any fees payable by the Operating Entity back to the Asset Owning Entity for use of the assets.  A liquidator may one day be examining these arrangements very carefully and any failure to properly document a loan, lease or licence may result in assets ending up with disgruntled creditors.

There may also be negative tax implications if you do not record these arrangements properly, from Division 7A issues to CGT and beyond.

Step two

Registering the security interest.

The Asset Owning Entity must also register its security interest in the business assets it is providing to the Operating Entity on the Personal Property Securities Registry (PPSR). The PPSR is a public notice system for interests in personal property (such as the assets used in the business).

Failure to register the fact that the Asset Owning Entity owns the business assets means people dealing with the Operating Entity are not aware of the fact that it does not own the assets it is using.  People trading with the Operating Entity could reasonably be mistaken for thinking the Operating Entity owns the assets.  For this reason, under our insolvency laws, if there is no registration and the Operating Entity fails, the assets are then available to meet the debts owed by the Operating Entity, even though the Operating Entity did not own the assets.

For the Asset Owning Entity to be able to take back its assets if the Operating Entity fails, the Asset Owning Entity needs to have registered its interest in the business assets on the public PPS Register. If this has not been done, the assets will be lost, and the ‘structural asset protection’ strategy of having business assets owned in a separate legal entity fails.

Note that real estate should also be owned in an entity separate from the Operating Entity, but it is not possible (or necessary) to register the ownership of the real estate on the PPSR. Real estate has its own registration system – the lands title system.

Succession planning

Think about what will happen if you die.

Don’t forget about succession planning when entering these arrangements, especially loan agreements.  Whilst you are alive you are likely to control the entities within the family group.  However, on your death, the debtor and creditor may end up in different and often competing hands.  This may put the business or the estate under financial stress and lead to disputes within the family.  You need to get your lawyer to document the terms of these in-house loans, to ensure that the debtor has time and ultimately the capacity to repay and to ensure your estate planning doesn’t lead to unintended consequences.

So in conclusion, as part of a complete risk management and asset protection strategy, you need to document in-house arrangements and to do it properly.

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