A guarantee given by a mother to a friend of her son for the son’s business debts ended up in court. There are lessons to again be learned from the outcome; and some law reform suggestions to be considered for SME businesses.
Although many people operate their small business through a limited liability company, they can become personally liable for their company’s debts through personal guarantees of those debts. If the company goes into liquidation, and is unable to pay, the creditor can claim on the owner of the company under the guarantee for the money owing. That can lead to the owner’s bankruptcy. Family members also often guarantee business debts.
Guarantees by friends are less common, wisely, as the opening Shakespearean stanza from a recent judgment advises:
Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry. [Hamlet, Act 1, scene III]
As the Queensland District Court Judge explained,
“this is another unfortunate case in which two people, having been taken advantage of by a friend and a son respectively, now battle over who should suffer the loss arising from that person’s failure to fulfil his promises. Neither of the parties is at fault, but one must suffer the financial consequences more than the other. I have sympathy for both, but I must decide the issues according to the evidence and the law”.
What happened
Mr Richardson was a friend of Mr Jason Wagner since high school and, more distantly, of his mother Mrs Wagner.
Richardson lent money totalling $150,000 – in the nature of his life savings – to Jason Wagner’s building company, the repayment of which both Mrs Wagner and Jason guaranteed.
The company then went into liquidation and Jason Wagner became a bankrupt.
Mr Richardson sought repayment of the money, including interest, from Mrs Wagner. She refused and he sued her, successfully.
The hearing
Richardson had lent money over time and regular repayments were made. In relation to a “major job in Cairns. About $200k worth”, Jason asked Richardson to increase his loan – “at that kind of money both mum and myself will be willing to provide personal guarantees”. Assurances were given that Mrs Wagner’s house was valued at over $900,000 and Jason had $200,000 worth of work coming in. The loan was documented.
At the hearing, Mrs Wagner unsuccessfully pursued various arguments. She tried to say she had not in fact given any guarantee – that her signature on the guarantee document “merely convey[ed] her approval of the contents of the document”, an argument described by the Court as “a nonsense”. She also argued that she was at a special disadvantage – “I was signing it to help Jason, but Jason assured me that it would be paid back and it would be – there would be no reflection on me at all” – and Mr Richardson took unconscionable advantage of her.
The outcome
The Court found her liable to Richardson for the amount owed to him, in excess of $195,000 including interest. The Judge noted that she could seek contribution from her son as co-guarantor but was uncertain whether this was a pre- or post-bankruptcy debt, the latter on the basis that Jason was only obliged to pay Mrs Wagner when she paid out Richardson, which would be after his bankruptcy.
While the Court said it did not need to decide, the answer is that it is a pre-bankruptcy provable debt. A debt of a company guaranteed by its director, as an example, is a contingent debt owed by the director to the guarantor, which becomes provable on the director’s bankruptcy. Richardson v Wagner [2021] QDC 24.
Lessons
There are lessons here about parents guaranteeing business debts, and about commercial relations with friends.
Beyond that, there are also law reform issues for small to medium enterprises (SMEs):
- Jason went bankrupt when his company collapsed and entered liquidation, perhaps because of his own guarantees to other creditors or lenders. This joint insolvency is common but the law requires the bankruptcy and the liquidation to be handled separately; a joint resolution in cases like this needs law reform attention, and is under review.
- Also, while a person in an SME may be protected by the limited liability feature of their company, and set up again soon after their businesses’ collapse, any personal liabilities can lead to their bankruptcy, restricting their setting themselves setting up again for 3 years or more. That also needs law reform attention.
- Then, in Queensland, licensed builders with an SME that has failed can be further restricted, whether they have personal liabilities leading to their bankruptcy or not.
Who’d be in business?
