What Happens to Personal Surety When a Company Is Liquidated?
When a company is struggling financially, directors often become concerned about the personal sureties they signed for company debt.
The immediate question is usually: If the company is liquidated, will I still be personally responsible for the debt? The answer depends on more than simply whether a surety was signed.
Liquidation does not automatically cancel a personal surety. However, this does not necessarily mean that the director will ultimately have to pay the entire amount owing by the company. The company's assets, money in its bank account, recoverable debtors and the ranking of creditors in the liquidation can all affect how much of the underlying debt is settled through the liquidation process and how much, if anything, remains outstanding under the surety.
What Happens to Personal Surety When a Company Is Liquidated?
A company is a separate legal entity from its directors. Ordinarily, a director does not become personally responsible for company debt simply because the company can no longer pay its creditors. Personal surety changes this position.
When you sign personal surety, you undertake in your personal capacity to be responsible for a particular company debt if the company does not meet its obligations. Liquidating the company does not automatically cancel that surety. However, it is important to distinguish between the continued existence of the surety and the amount that may ultimately remain owing to the creditor.
If the creditor receives payment from the company's liquidation estate, that recovery may reduce the outstanding debt.
The practical question is therefore not simply: "Did I sign surety?"
It is also: "After the company's assets and recoveries have been dealt with in liquidation, how much of the debt covered by my surety will actually remain?"
Can Liquidation Reduce the Amount Owing Under My Personal Surety?
Potentially, yes. When a company is liquidated, the liquidator takes control of the company's estate and identifies the assets and amounts that may be recovered for creditors.
Depending on the particular company, this may include:
property owned by the company;
vehicles, machinery and equipment;
stock;
cash held in company bank accounts;
money received into the company's bank account after liquidation;
outstanding debtors that can still be collected; and
other assets or recoverable amounts belonging to the company.
These amounts do not simply get divided equally between all creditors. Creditors are paid according to their legal ranking and the nature of their claims. The amount ultimately recovered by the creditor holding your surety will therefore depend on the assets available, the creditor's ranking and the other claims against the liquidation estate.
How Are Creditors Ranked in a Company Liquidation?
Not every creditor has the same rights to the proceeds recovered during liquidation. Creditors are paid according to the ranking of creditors prescribed by law and the nature of their claims. Broadly, creditors may fall into three important categories.
Secured Creditors
A secured creditor holds security over a particular asset. For example, a bank may hold security over property or another asset belonging to the company. The secured creditor is paid from the proceeds of the asset over which it holds security, subject to the applicable costs and legal requirements. If the proceeds are insufficient to settle the secured debt completely, the remaining shortfall may rank as an unsecured claim against the estate.
Preferent Creditors
Certain creditors receive statutory preference from the available free residue of the estate. These claims rank ahead of ordinary concurrent creditors and can include certain employee claims and claims by SARS, subject to the applicable statutory provisions and limits.
Concurrent Creditors
Ordinary unsecured creditors generally rank as concurrent creditors. They share proportionately in the free residue that remains after the claims ranking ahead of them have been dealt with. This ranking can make a significant difference when considering a director's personal surety. It is therefore not enough to look only at the total value of the company's assets and compare this with the total amount of its debt. We also need to establish which assets are secured, which creditors rank ahead of others and how much may realistically be available for distribution to the creditor holding the surety.
An Example of How This Could Affect a Personal Surety
Assume a company owes a bank R500,000 and the director signed personal surety for that facility. Liquidation does not automatically make the R500,000 disappear. But neither should we automatically assume that the director will personally have to settle the full R500,000.
Suppose the bank ultimately receives R300,000 through the realisation and distribution of the company's estate. The amount still outstanding to the bank would then be materially different from the original R500,000 debt.
The director's potential exposure under the surety would need to be considered against the remaining balance and the terms of the surety agreement. In some cases the liquidation estate may settle only a small portion of the debt.
In other cases it may settle a substantial portion. Where sufficient assets and recoveries exist and the relevant creditor receives full payment, there may ultimately be no remaining underlying debt for the creditor to recover from the surety. The outcome therefore depends on the actual financial position of the company and the creditor's rights in the liquidation.
Could All of the Debt Be Settled Through Liquidation?
It is possible. A company may have valuable assets, substantial recoverable debtors or cash available that results in a creditor receiving a significant distribution or even being settled in full. In practice, however, companies frequently reach liquidation only after experiencing financial distress for some time. By this stage, directors may already have sold assets in an attempt to keep the company operating, pay employees or settle pressing creditors.
Customers who owe the company money may also have stopped paying, or outstanding debtors may be difficult to recover. Cash reserves are often already depleted.
For this reason, there may be considerably less value remaining in the company by the time liquidation becomes unavoidable. But this should never simply be assumed. Before determining the director's likely personal exposure, the company's remaining assets and potential recoveries should be properly assessed.
What About Money Owed to the Company by Its Customers?
Outstanding debtors can be important. Money owed to the company is an asset of the company. The fact that the company has stopped trading or entered liquidation does not automatically mean that customers no longer have to pay legitimate amounts they owe. Those debts may be collected as part of the liquidation process. There may also be payments received into the company's bank account after the liquidation process has commenced in respect of invoices or work completed previously.
These recoveries form part of the financial picture that ultimately determines what is available in the estate for creditors. The value shown in the company's debtor book should, however, not automatically be treated as cash that will definitely be recovered. A debtor book may contain disputed accounts, old debt, customers who are themselves experiencing financial problems or amounts that are otherwise difficult to collect. The recoverable value is therefore more important than simply the amount appearing in the accounting records.
Where Do Directors Commonly Sign Personal Surety?
Directors may have signed surety when the company obtained:
a business loan or overdraft;
a business credit card or banking facility;
vehicle or equipment finance;
a commercial lease;
supplier credit; or
another form of business finance.
Sometimes directors remember signing these documents. In other cases, the surety was contained in a larger credit application, banking agreement, finance agreement or lease signed several years earlier. It is therefore important not to assume that you did or did not sign surety. The actual agreements should be checked.
Does All Company Debt Become the Director's Personal Debt?
No. This is an important distinction.
If a company owes R2 million, liquidation does not automatically mean that the director personally owes R2 million. A separate legal basis must exist for holding the director personally liable. Personal surety is one possible basis.
If the director signed surety for a particular banking facility but did not sign surety for other company creditors, those other debts do not automatically become the director's personal debts simply because the company is liquidated. There are other circumstances in which personal liability may arise, but those are separate issues that need to be considered on their own facts.
Can the Creditor Claim Against Me After Liquidation?
Where a valid personal surety exists, the creditor may still have a claim against the person who signed it. The extent of that claim will depend on the wording of the surety, the outstanding debt and the circumstances of the particular matter. It is also important to remember that resigning as a director does not necessarily cancel a surety signed previously.
Leaving the company and being released from personal surety are two different things. If you previously resigned from the company but signed surety while you were involved in it, the agreement should be checked to establish whether you were ever formally released. If you were not released then regardless of the resignation, you are still personally liable for the personal surety you agreed to originally.
What If More Than One Director Signed Surety?
This will depend on the agreements that were signed. A creditor may have obtained surety from one director, several directors or other people associated with the company. The wording of those agreements determines the potential liability of each person. You should therefore not assume that the outstanding debt will simply be divided equally between the people who signed surety. Each agreement needs to be considered.
What If I Cannot Afford the Amount That Remains?
Only once the likely personal exposure has been identified does it make sense to consider what the director should do about it. The company liquidation and the director's personal financial position are separate matters, but they should often be assessed together.
A director may discover that the liquidation estate will materially reduce a debt covered by surety and that the remaining amount can be managed personally. Another director may discover that several substantial sureties will remain and that the resulting personal debt is no longer realistically affordable.
Depending on the circumstances, possible solutions may include negotiating with creditors, restructuring personal finances, dealing with financed assets or considering a formal personal insolvency solution where appropriate. Sequestration should not automatically be assumed to be necessary simply because a director signed personal surety. The amount that is actually likely to remain, together with the director's income, assets, property, financed vehicles and overall affordability, should be considered first.
Personal Surety Should Be Assessed Before Liquidation
Ideally, this assessment should take place before the company is liquidated.
Prepare a complete list of the company's creditors and establish:
how much each creditor is owed;
whether the debt is secured;
what assets remain in the company;
the realistic value of those assets;
what money is currently held in the company's bank accounts;
what outstanding debtors may still be recoverable;
which creditors may have preferential claims;
whether the director signed personal surety;
the amount covered by each surety;
whether more than one person signed surety; and
whether legal action has already commenced against the company or the director personally.
This gives a much clearer picture of what liquidation is likely to resolve and what personal exposure may remain afterwards.
Liquidation May Resolve More Than the Director Initially Expects
The existence of personal surety does not mean that liquidation will have no benefit for the director.
Liquidation deals with the company and brings its assets, creditors and outstanding affairs into a formal insolvency process. Where assets and recoveries exist, those amounts are distributed according to the ranking of creditors and may reduce the underlying debts. That can, in turn, reduce the amount ultimately remaining under a personal surety. The correct approach is therefore not to assume either extreme.
Liquidation does not automatically cancel personal surety, but signing personal surety does not automatically mean that the director will personally have to pay the entire original company debt. The company's assets, recoveries, creditor ranking and the terms of the surety all need to be considered.
Get the Complete Position Before You Liquidate
If your company can no longer pay its debts and you are concerned about personal surety, Solvendi can assess the company and your potential personal exposure before the liquidation proceeds. We consider the company's creditors, remaining assets, recoverable debtors, available funds, creditor ranking, personal sureties and any legal action already underway. This allows you to understand what may be resolved through the company's liquidation and what may remain your personal responsibility afterwards.
Contact Solvendi for a confidential assessment of your company's financial position and a clear explanation of the options available.
Disclaimer: This article is intended for general informational purposes only and should not be regarded as legal advice. The appropriate solution will depend on the company's particular financial position, tax affairs and liabilities. Professional advice should be obtained regarding your individual circumstances.
Contact us to discuss your current situation and receive a free detailed assessment of how the process works and what your costs will be. We have legal experts with 20 years experience that can guide you through the process. Our main aim is to be as informative as possible. Let's Chat.
If you require advice with regards to Sequestration, Business Liquidations, Insolvency, Bankruptcy or Credit Rehabilitation kindly contact SOLVENDI as follows:
National: 087 220 0710
Head Office: 010 880 7589
Email: consultations@solvendi.co.za
Website: www.solvendi.co.za
Comments