Top 5 Myths Around Legal Entities – Debunked!
Reducing exposure to risk is a priority for credit managers offering commercial credit. Here we debunk some commonly held misconceptions when it comes to assessing risk for different entity types.
Most of these false beliefs relate to the credit agreement entered into with new customers. For robust protection of your financial interests, it’s important to know from the start the type of legal entity your applicant is. Are they a sole trader, a partnership, a company or a trust? There are other corporate structures but in the majority of cases this is what most credit professionals would expect to see. You need to know these facts as the liability behind these structures can impact your ability to collect an outstanding debt in the event something goes wrong.
The recent 2019 Equifax National Credit Managers Survey showed that 73% of credit managers experienced a rise in credit demand in 2019, compared with 2018. With this increased credit activity, it’s more important than ever to protect your business from bad debt.
Beware of these myths which might weaken your knowledge of who you are doing business with and make it harder to recover any debts which may arise.
Myth # 1: A trust registry database is a reliable way to identify trust applicants.
Truth: A Trust Deed is the only source of truth to accurately assess the credit risk associated with your application.
The Equifax Credit Managers survey showed that trusts make up 25% or less of the customer base for most respondents, yet they often cause an automated assessment process to become manual. If your customer applies as a trust, it’s vital to identify the legal entity behind this structure. A trust is not a legal entity – it holds assets, but it doesn’t control these assets. Control, or ‘legal title’, is in the hands of the trustee or the appointer, which could either be a company or one or more individuals.
Because it’s not easy to sort out who the legal entity is in a trust, the idea of a trust registry database is understandably attractive. After all, who wouldn’t like to swap a manual process with an automated solution for linking trust applicants to the individuals behind them? The problem with this scenario is that trust deeds change. In Australia there is no legal requirement for trustees to notify a government registry of changes to the trust deed. As such, there’s no regulated central register to refer to when processing trust applications, and no guarantee the information held in a trust register is up to date.
The only way to reliably find out who is the legal entity behind a trust is to look at the trust deed at the point of application. It’s here that you will be able to identify who is the trustee or appointer. And it is this entity, not the trust, who is personally liable for any debts.
In Australia, as of 30 June 2019, there were:
375,000+ new business name registrations
220,000+ new company registrations
Myth # 2: An ABN search is sufficient when gathering information about a company.
Truth: An ACN search is far more insightful and is the correct number to rely on when assessing credit risk.
For most respondents in the Equifax Credit Managers Survey, the largest portion of their customer base is stated to be companies. For 71% of respondents, companies consist of more than half of their customer base. So for many credit managers, verifying company information when entering into a credit agreement is a routine task. But it’s a task not always performed correctly.
When gathering information about a company, it’s far better to search for the Australian Company Number (ACN) rather than the Australian Business Number (ABN).
If your customer is registered to trade under a company structure in Australia, they will have an ACN issued by the Australian Securities and Investments Commission (ASIC). An ACN assists ASIC to monitor company activities because it is a unique identity code within the structure of the Corporations Act 2001 (Cth).
Myth # 3: A trading name or a business name is a legal entity.
Truth: The legal entity is the individual behind the trading/business name.
What’s in a name? A business registered with the Australian Business Register is no more a legal entity than a company with a trading name. It’s the individual behind the business who holds the title of ‘legal entity’, and that is with whom you should be dealing.
To fully understand the risk and exposure of doing business with a new customer, it’s important to investigate the background of the legal entity. A company credit report or consumer file are great places to start.
Myth # 4: When dealing with a trust on the PPSR, only register against the trust.
Truth: It’s best practice to register against both the trust and the trustee.
When asked about future plans in The Equifax Credit Managers Survey, 16% of respondents said they were going to register their security interests this coming year. Two-thirds of respondents had already registered on the Personal Property Securities Register (PPSR), with the majority feeling confident their entries were correct. The unfortunate reality is this confidence might be misplaced, especially when it comes to trust registrations.
When registering security interests over trust assets on the PPSR, don’t make the mistake of only registering against the trust. Instead, take out two registrations – one against the trust and the other against the trustee. Remember the trust doesn't control the assets, the trustee does.
Where a trust is the grantor of a security interest and has an ABN, register against the ABN. Also, register against the trustee’s ACN. You will need to obtain the correct identifying information for the grantor; otherwise, there is a risk the PPSR registration will be deemed incorrect or invalid. We recommend seeking specialised advice.
Myth # 5: It’s not essential to identify the correct legal entity.
Truth: If you don't identify the correct legal entity from the start, it limits your recourse for debt collection.
Over the coming 12 months, 65% of credit managers plan to increase or tighten credit activity, according to The Equifax Credit Managers Survey. A crucial part of mitigating risk is to identify the correct legal entity when extending credit. If a customer fails to repay their debt and you haven’t been trading with a legal entity, this may seriously impede the success of your debt collection activities There is a clear correlation between getting the correct legal entity right and lessening your chance of needing to collect through a third party down the track.
Head of Commercial
T: (02) 9278 7699
Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstance before acting on it, and where appropriate, seek professional advice from a finance professional such as an adviser.