Commercial Law

Heads of Agreement (HOA)

HOA are a summary of the key commercial terms agreed between the landlord and tenant prior to entry into a formal lease. HOA include the description of the premises, the commencement date, the length of the term plus option (if applicable), the starting rent and mode for review, security (bank guarantee or bond), the right of the tenant to carry out works (fit-out) and the payment by the tenant of outgoings.

There is also invariably a reference to the tenant’s obligation to “make good” at the expiration of the term or earlier termination of the lease which may lack detail or not match more onerous provisions in the formal lease document. Although it is not always possible due to the pace of the transaction and pressure from the landlord and/or agent for a commitment, the tenant’s solicitor should review the HOA before being signed by the tenant.

Which Business Structure and Why?

If you’re contemplating starting a business, the four (4) most common business structures are:

• Sole Trader
• Company
• Partnership
• Trust.

Sole Trader

If you are a sole trader, you operate the business as an individual and you are the sole person legally responsible for all aspects of the business. All profits derived from the business will be treated as your personal income and taxed at marginal rates. It is the least costly to run of the available structures.

Company

A company operates as a separate legal entity to the shareholders of the company. Any profit of the business is earned by the company and not the shareholders. The liability of the shareholders for the debts of the company is limited to the amount of any unpaid capital on the shares.

Having paid tax at the flat corporate rate, the company may then reinvest the surplus or declare a dividend and pay the shareholders. Depending on who holds the shares, there could be further tax paid at the shareholder level. To add flexibility, shares in the company are often held by family discretionary trusts associated with the business founders. The dividend paid to the trust can then be streamed to the beneficiaries of the trust at the discretion of the trustee.

Partnership

A partnership exists where two (2) or more entities carry on business together with a view to profit. There is usually a partnership agreement regulating and governing the operation of the partnership and the rights/obligations of the partners. The structure is relatively simple and inexpensive to establish and although not a separate legal entity at law, the partnership will be required to file a separate tax return.  At the end of each financial year, the accounts of the partnership will disclose a profit or loss which will then be allocated to the individual partners at the partner level. There is no tax payable by the partnership. The members of the partnership may be a combination of different legal entities and it is not uncommon for there to be a partnership of family discretionary trusts.

The downside is that all partners are jointly and severally liable for the debts of the partnership.

Trusts

Broadly, a trust is an entity that holds income or property for the benefit of others (the beneficiaries of the trust). In business, they are primarily used to minimise individual risk and facilitate the distribution of income to the beneficiaries of the trust (be they individuals, companies or other trusts).

More recently, the use of trusts in business and trading activities has again attracted the attention of the ATO resulting in the publication of a set of guidelines (so-called safe harbour arrangements) relating to distributions from the trust. Although there is no guarantee from the ATO, it is generally accepted that adherence to the safe harbour arrangements should mean that an audit is unlikely.

In the absence of a shareholders agreement, the rights and obligations of shareholders in a private company will be regulated by the company’s constitution, the Corporations Act and the general law. In circumstances where there is only one shareholder or a husband/wife family company, there would be no need for a shareholders agreement. Where the share ownership involves unrelated individuals or entities, a shareholders agreement will be recommended for the following reasons:

• It will provide shareholders with the scope and opportunity to do things differently to the default position under the constitution and the general law.
• If you are a minority shareholder you may want the right to appoint a director, the right to the provision of certain minimum information and the right to tag along with a major shareholder who is selling shares.
• If you are a major shareholder, you may want to ensure that minority shareholders cannot obstruct decision making or do not have the ability to drag along the other shareholders into a sale of the company.
• A shareholders agreement can be modified or amended under its terms whereas the constitution can only be changed by special resolution which requires the giving of notice and the approval of 75% of the shareholders entitled to vote.
• A shareholders agreement can ensure differing levels of shareholder approval depending on the subject matter.

In addition to the above, a shareholders agreement could also record the nature and objectives of the company, how decisions will be made with respect to a range of issues, when and how shares can be issued, sold or redeemed and how disputes can be resolved without selling the business and liquidating the company.

Why your Business should have a Buy/Sell Agreement

A buy/sell agreement (or “business will”) is a contract entered into by business proprietors pursuant to which the proprietors agree to buy out the interest of another proprietor should a trigger event occur. The event may be the death, trauma or total or permanent disablement of a proprietor. The agreement can be structured in such a way that it does not matter what business structure has been adopted (trust, company or partnership). To finance the transfer of equity, the proprietors will usually take out some form of insurance. This is most important where the value of the equity is substantial. In the absence of such funding, the remaining proprietors might not have access to sufficient funds to buy out the exiting proprietor or their estate.

The buy/sell agreement will minimise the risk of:

• Remaining proprietors having to sell the business or take out additional funding to buy out the departing proprietor or their estate
• Assets of the business being frozen due to legal issues created by the departing proprietor, their family or estate
• Members of the departing proprietor’s family deciding to become active business proprietors
• The departing proprietor’s spouse or family taking up their legal right to claim a share of business profits without actually working in the business
• A departing proprietor’s spouse or estate selling the share to an unsuitable third party.

Consider the following scenario. You are the sole director/shareholder of your trading company. What would happen if you died or became incapacitated? How would the company continue to operate?

Companies can only operate through their directors. If you are a sole director/shareholder and unable to act, the company’s operations will be effectively frozen. In the case of incapacity, your duly appointed attorney (standing in your shoes as shareholder) could appoint a replacement director. In the case of death, the company would be frozen until a Grant of Probate of your personal estate gives the executor under your Will the authority to step in and deal with the shares pursuant to the Will.

Far simpler and more practical is for the company to have in place a Corporate Power of Attorney.Under the Corporations Act, a company can appoint an attorney to act on its behalf when it is unable to do so. Generally, it would be recommended that the attorney be the same person/s that you have appointed as the executor/s under your Will. In the event of your demise, the executor could begin acting as the company’s attorney immediately without having to wait for a Grant of Probate (which could take several weeks/months).

Loans to Family Members

Financial assistance from parents to adult children attempting to break into the residential property market is now more prevalent than ever and can be either by way of outright gift or loan. There appears to be two (2) drivers for the loan arrangement:

• The parents’ resources are not limitless and there is the very real expectation that the loan will be repaid
• Parents are justifiably concerned that if the assistance is by way of gift, the moneys advanced will become part of the matrimonial pool should the Child marry and then separate. In other words, if the monies are not considered to be a loan, the funds will form part of the matrimonial pool and not deducted at the time of the property settlement.

It is crucial that the loan be properly documented and secured. In the absence of documentation, the Family Court will almost certainly regard the money as a gift and accept it as forming part of the matrimonial pool and not repayable to the parents.

You will need:

• A properly drafted Deed of Loan with commercial terms that would include a date or triggering event for the repayment of the principal, the charging of interest at a rate reflective of the transaction and provisioning for acceptable security;
• An unregistered mortgage that references the Deed of Loan; and
• The lodgement of a caveat on the title to the property to ensure the repayment of the loan should there be an attempt to sell the property without notice.

Although it may seem trite, the above documentation should be in place before any money is advanced.

Security over Non-Real Estate Assets

If you are proposing to lend money to a business or company with no real estate assets, you may need to take security over the plant, equipment or other items of personal property. In New South Wales, the Personal Property Securities Act 2009 (‘PPSA”) sets out uniform rules dealing with the taking of security over personal property, as distinct from real property. Specifically, the PPSA has created new classes of security documentation – specific security agreements (over a particular asset or assets) and general security agreements (where the agreement covers all the assets and undertakings of the business or company – previously referred as a fixed and floating charge when given over a company).

Both classes of document must be registered with the Personal Property Security Register (the PPSR) which is essentially an online national noticeboard that displays and preserves the priority status of the security interest in the collateral against others.

Failing to register (or perfect) the security interest in time could result in loss of priority against other secured parties or loss of ownership of the collateral upon liquidation.