Review for Accountants & Financial Planners
May, 2015

Debt Insurance and housekeeping issues

Two minute scenarios...

Some business clients choose to take stand-alone debt insurance cover. However, there are issues to consider.

Scenario One... Stuart and Paul

Scenario: Stuart and Paul are business partners. They took out debt insurance a year ago to cover their overdraft in case one of them died or suffered a TPD. They know that not only is the business vulnerable when a key person leaves, but the bank may also be able to call in the debt. Stuart had a heart attack and passed away a few months ago.

What's the issue? Paul has used the insurance funds to pay trading creditors and not the overdraft. Stuart's wife has a problem. The estate can’t be wound up unless the personal guarantee on the debt is released. There was no agreement in place to force Paul to pay the bank the insurance funds.

Solutions: Stuart and Paul needed to have a Debt Insurance Agreement drawn up to obligate the remaining partner to use the funds to pay down the debt in order to extinguish the personal guarantees.

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Scenario Two... only their 'share'

Scenario: Stuart and Paul had a $500K overdraft and had both signed joint and several guarantees. Despite each guaranteeing 100% of the $500K debt they decided to only take out $250K life and TPD cover each.

What's the issue? Whilst the $250K cover may be used to pay down the overdraft, the bank is under no obligation to release a guarantee, even if the individual is no longer an equity partner.

Solutions: Ideally each partner would take insurance to cover the full amount. However at the very least, a Debt Insurance Agreement would not only ensure the remaining partner paid down some of the debt, it would obligate them to use their “best endeavours” to negotiate with the bank to release the guarantee.

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Scenario Three... business debt, self-owned policies

Scenario: Stuart and Paul did not want to pay extra to cover any CGT on the TPD policies which would be applicable if the business owned the policies. They chose to self-own on the understanding the proceeds would be gifted to the business to pay down the debt.

What's the issue? As executrix, Stuart's wife has received the $250K but she keeps the cash. There is nothing in writing about the agreement. Paul asks her to gift the money to the business. However, she has a duty to properly manage the estate and will be in breach of her duties as a fiduciary if she chooses to do that.

Solutions: If there was a Debt Insurance Agreement in place, Stuart's wife would be required to gift the money to the business.

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