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SME Owners, This Is What You Need To Know About Bankruptcy

We’ve talked about dealing with personal bankruptcies – but not much has been written about how bankruptcy affects small businesses. Before we discuss this issue, let us shine the light on the following concepts.

What is the difference between bankruptcy and winding up your business?

Bankruptcy refers to an individual person who owes money and has is unable to repay their debt. The term “winding up” often means that a “private limited” company is not able to pay their debts.

Unlike the former, the liabilities of the company will usually not be carried over to the individual shareholders or even directors of the company.

However, there are circumstances where individuals may become liable. Here are some possible scenarios:

  • When a company director provides a personal guarantee for the company, such as for bank loans. If the company is unable to repay the amount, the director may become liable.
  • The company is not a “limited” entity. This means that the business owners are personally liable for debts or legal action taken against the business.
  • When a company director breach their duties, such as committing fraud, they may become exposed to personal liability.

What can SME owners do to prevent bankruptcy?

Despite spending over two decades as a court lawyer, I still find it shocking that most business owners do not bother to take any form precaution to prevent or reduce the risk of personal exposure to bankruptcy.

Here are some simple steps that every business owner should start taking (if they have not done so already):

1. Don’t sign legal documents blindly.

We have met many clients who blindly sign legal documents such as bank loans, security documents and guarantees. When asked to explain this behaviour, their responses tend to be along the lines of: “these are standard terms” and “small businesses have little bargaining power with banks”.

Wrong!

There are more than 200 banks and financial institutions in Singapore. There is also a variety of financial instruments besides the traditional methods of grants, loans and investment that you can utilise – contact us if you’re interested to find out more.

While it may not be possible to alter the terms and offer given by banks, you have the power to walk away and find alternative financial service providers. If you must sign on the offer, at the very least, you should understand the scope or extent of the risks.

Create a solid foundation by getting a legal opinion on how to structure your business in order to mitigate the above risks.

2. Stop relying solely on “guanxi”.

Asian business typically rely on guanxi (关系) and may even prioritise it above the law.

Guanxi will not protect you when an unhappy customer, employee, partner or investor lodge a complaint against the business owners in the Courts. Ultimately, it is the law that will determine whether you will be personally liable. You cannot escape or hope to escape the law simply by having personal relationships.

Good corporate governance dictates that the business owner must create a clear division between their personal interests and their companies’ interests.

When it comes to the companies’ business and interests, you should engage lawyers to draft or review the agreements. If the business owners draft and review their own agreements, they may unwittingly expose themselves to negligence personally.

3. Understand that there is no standard formula for picking the right business structure.

There are at least five different types of business structures. They are not there for fun.

Depending on the tax plan, management control plan, liabilities and financial plans, lawyers can advise on what is the appropriate structure to use.

ACRA has made it so easy for business owners to register or incorporate business entities, that this creates a perception that maintaining and managing the risks associated with each entity is also an easy exercise.

It is very common to see business owners opening over ten different incorporated companies. Some of them are dormant and some are active. Many do not know that such conduct can trigger a red flag in the tax authorities for tax evasion activities.

Financial institutions and lawyers may also view them as potential sham companies to defraud creditors. As a result, the business owners increase their risk of compliance lapses and breach of duties.

Contact us for specific legal advice on the information provided in this post or related topics.

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