2.1 This chapter outlines the background social and financial environment in which guarantee transactions take place. It examines the context of family business and small business in which borrowing takes place, so as to better understand why guarantees are considered necessary and how financial risk comes to be transferred from the borrower to the guarantor. It also briefly outlines the regulatory environment surrounding consumer loans and highlights the extent to which current guarantee practice is excluded from that framework.
SMALL BUSINESS AND FAMILY BUSINESS
2.2 Family businesses comprise a significant part of the Australian economy, yet there is little available information on how they are run, the dynamics of their operation, why they borrow, and why they fail. This chapter relies upon the few research studies and surveys into family business and family finances to draw some tentative conclusions about the background in which many guarantees are likely taking place.
2.3 There are over a million small businesses in Australia. Over 96% of all businesses in Australia are small businesses.3 The 1997 Australian Family Business Survey, conducted by Monash University, found that family business represents 83% of all private sector firms, and employ more than 59% of the workforce.4 The survey found that women represent approximately 3% of owners. The majority of family businesses have only one or two directors5 with around half having only two shareholders.6
2.4 While clearly important to the business sector, family businesses are marked by a distinct lack of longevity. The Australian Family Business Survey found that between two-thirds and three-quarters of family businesses either die out or are sold out of the founding family during the first generation, and only 5-15% continue into the third generation.7 There is no comprehensive analysis of the reasons for poor longevity.
2.5 It is also noteworthy that family businesses are structured differently from non-family businesses. In family businesses the owner generally has a duty to look after the welfare of the business and family members and this can lead to conflict. The Australian Family Business Survey, found that only 22% of family business owners had a process for dealing with conflicting family and business issues. Of those, only 8% had the process documented.8 In this context, there is significant potential for liability relating to the activities of the family business to be transmitted to other family members.
2.6 A recent Australian empirical study found that family businesses tend to rely on private sources of finance such as loans from family and friends for start-up and growth rather than funding via public markets. That study speculates that this proclivity is likely to be related to their intentions to retain control and minimize financial risk.9 While our research did not specifically inquire into financial risks, it was clear that using private family sources as security for business loans involved high risk which in many instances lead to disastrous results, such as the loss of the family home.10
WOMEN IN FAMILY BUSINESSES
2.7 Much of the decided case law on third party guarantors of family business debts involves an analysis of the roles of family members in the relevant business. This is because in many cases involving women who guarantee their husband’s business debts, the benefit that spouse receives, or expects to receive, from an enterprise is a critical issue in determining whether relief will be given.11 In third party guarantee litigation, the lender may claim that even if a woman has no participatory or decision-making role in the company activities or where its profits are directed, she nonetheless obtains an indirect benefit as a shareholder or director or because the company provides income to the family.12
2.8 There is comparatively little known about the dynamics of family businesses.13 Courts have tended to assume that benefits to one party in a marriage automatically flow to the other, or that if a woman has a formal role in the business, then she is actively involved in the decision-making within that enterprise. This approach does not take into account economic research that questions such assumptions.14 Two studies which investigate how domestic decisions impinge on family business decision-making are relevant to this research. In Australia, Supriya Singh researched how women participate and inform themselves in family businesses,15 and in England, Belinda Fehlberg undertook a detailed empirical study of women’s involvement in family businesses.16
2.9 In the Fehlberg study, a large proportion of those women who identified themselves as having no day-to-day involvement in the family business nonetheless provided significant financial support by way of third party guarantees.17 Furthermore, those “non-participating” women were also often company directors, secretaries or shareholders. For such women their formal position in the business did not correlate with their actual participation; and certainly none had considered exerting their formal legal rights (as directors or shareholders) to obtain a direct financial benefit.18
2.10 A comparative analysis of the data from the English and Australian surveys reveals that while most women surveyed in the Australian study described a high level of involvement in the family business compared to the English study,19 this did not translate into equal power within the business. Singh describes this situation as “informed powerlessness”, that is, where a woman is informed about the finances and business, but is still unable to influence or be active in final decision-making. This inability to influence strategic decision-making is consistent with the English study, and Fehlberg observes that collectively these studies undermine the assumption that non-participation or lack of information of themselves explain women’s lack of power in family businesses.20 This dichotomy between information and decision-making power is evidenced in the casework of financial counselling services.21 Other research in the United States also confirms the entrenchment of gendered roles in business and business decision-making.22
2.11 Fehlberg concludes from her analysis that “women, and particularly economically-dependent women in middle and higher-income households, are likely to be called upon to provide security and to find it difficult to refuse if asked”.23
2.12 These studies suggest that great care should be taken of the way that women’s involvement in family companies is analysed and assessed by the courts when they consider women’s actual involvement in and benefit (if any) from the family business.24 The suggestion that the provision of extra legal or financial advice to women about their roles and activities within a business will alleviate difficulties with guarantee transactions may well be misconceived. Lack of information does not appear to be the major problem – the underlying issue is the absence of power or opportunity that would enable effective and active decision-making.
FAMILY SUPPORT FOR FAMILY COMPANIES
“Once again the Court has before it an appeal involving a claim by a female spouse for relief under the Contracts Review Act 1980 (the Act). The claim relates to a legal transaction entered at the request of the male spouse.”25
2.13 In our research information about borrowers was obtained from guarantors, solicitors, barristers and judges, as well as from a review of recent litigated cases. Borrowers themselves were not directly surveyed.
2.14 We anticipated that there would be a high number of male borrowers and company borrowers, both supported mainly by female guarantors. This was confirmed by the data.
2.15 The review of litigated cases revealed that men were the principal or sole borrower in 42% of the pool of cases assessed. No cases in our pool revealed a female primary borrower. A third of the cases analysed involved a family company as the borrower. Ninety per cent of borrowers in the litigated cases were individuals, or companies owned and run by individuals, who were related to the guarantor. Our surveys revealed very similar results with between 70% and 80% of guarantors in a familial relationship with the borrower. The relationship between the borrower and guarantor is discussed in more detail in Chapter 3: Who are guarantors and why do they sign?
2.16 When we examined business loans specifically, the findings from family business studies cited earlier were clearly borne out.
2.17 Thirty-seven per cent of guarantors surveyed had “no role” in the business whose loans they guaranteed; another 9% identified themselves as having “no formal role” in the business. This accords with Fehlberg’s study in the UK in which half of the guarantors described themselves as having no role in the business for which they secured a loan.26
2.18 A further 20% of our guarantor respondents were “silent” directors of the business. Only 16% were active directors of the business whose loan they had guaranteed.27 A closer analysis of this data reveals that the largest percentage of guarantors were women with no formal role in the business for which they provided a guarantee.
figure 2.1: role of guarantors in the business
HOW MUCH ARE THEY BORROWING AND WHY?
2.19 The review of litigated cases, solicitor, barrister and guarantor surveys all revealed substantial proportions of loans made for business purposes. Of the litigated cases, 94% related to a business loan. Barristers and solicitors reported 70% and 98% respectively of guarantees were for business loans the last time they dealt with a third party guarantee transaction. The survey of guarantors found 49% of loans relating to a business purpose, a lower but still considerable proportion.
2.20 Of the guarantors surveyed 48% were involved with loans of less than $50,000, while 26% were involved with loans of between $50,000 and $200,000 and 24% were involved with loans of over $200,000. Solicitors and barristers reported significantly larger amounts at stake in the transactions they last dealt with.28 Our analysis of litigated cases also revealed far higher amounts than those reported by guarantors.29 It is logical that the involvement of lawyers and the use of litigation correlated with high value transactions. The smaller value of loans in the guarantors survey also correlates with the proportion of guarantees that were for non-business purposes (such as loans to purchase cars for individual use).
2.21 We were interested to discover whether guarantees were being sought to support finance for businesses that were starting up or expanding, or for a business that was in difficulty or had loans that were already problematic. From our survey it appears that expansion, rather than start-up or later difficulties, was the principle reason for the loan. Of the guarantors who were supporting a business loan, 25% reported that the loan was for a new business, 19% reported that it was to get the business through a difficult time (although a further 8% of respondents said that it involved refinance of an existing loan), while 38% stated that the purpose was to expand or develop an existing business. While a sizeable proportion of guarantees are therefore taking place to assist a business that it already ailing, it appears that the majority of guarantees in our pool were undertaken in a climate of optimism.
figure 2.2: purpose of business loans
2.22 This data is somewhat at odds with that in Belinda Fehlberg’s study. Although a similar proportion of loans were for business expansion, only one guarantee in Fehlberg’s study involved support for a new business and the majority of guarantees were for a business in trouble.30 However Fehlberg notes that whether a business was in trouble or was new or expanding, debtors were rarely in a position to present the risks inherent in the guarantee objectively. Whether in a state of financial pressure or high optimism, borrowers were highly partial and selective in the manner in which they presented their business to the guarantor.31
TYPES OF LOANS: THE BUSINESS/CONSUMER DISTINCTION
2.23 The Uniform Consumer Credit Code regulates the provision of credit where it is provided wholly or predominately for personal, domestic or household purposes.32 The Consumer Credit Code is enacted in legislation in each Australian state.33 Consumer loans benefit from provisions that require lenders to provide plain language documents, cooling off periods and the provision of warnings and information to prospective guarantors. The safeguards provided by the Consumer Credit Code are not available for business or certain types of mixed purpose loans. The regulation of guarantees of business loans is therefore significantly more limited than the protections available where the guarantee is provided to support a loan which is essentially of a personal or domestic nature.
2.24 The Commission’s Issue Paper noted the widening gulf between laws regulating business finance and consumer finance and the policy behind maintaining those distinctions.34 Many submissions to the Commission advocated abandoning those divisions. Some were of the view that people entering guarantees for business loans are not necessarily more sophisticated than guarantors supporting consumer loans.35 Another submission noted the ability to make things or provide a service does not mean that business people necessarily have any more financial understanding than consumers in general.36 Furthermore, issues such as power imbalances and relative economic circumstances are just as relevant in many small business loans as they are in relation to consumer loans.37 Small business guarantors do not have access to the same statutory legal protections prior to entering into a guarantee transaction and may have more limited access to assistance from community legal centres or legal aid to assist them with subsequent disputes.38
2.25 The Commission’s Issue Paper identified the need to review the continuation of the distinction between business and consumer loans.39 The categories are not two diametrically opposed categories, but in practice may operate along a continuum with mixed purpose loans that use a mortgage to support both a family business and some measure of personal spending, such as home expansion or repairs.
2.26 The presumption that people entering into guarantees for businesses are more sophisticated, more empowered or on a more equal bargaining footing than those guaranteeing personal loans was not borne out in our research.
CONCLUSION
2.27 Small business represents a significant and fundamental part of the Australian economy. Utilising the equity in personal assets such as the family home is a convenient and common way to raise capital to start-up and/or to expand a business. Belinda Fehlberg argues that:
“While it is in everybody’s interests to ensure that small businesses have access to the capital they need, there is a need to undermine the link between suretyship by loved ones and business financing.”40
2.28 Most family businesses are owned and run by men, with little involvement from female partners. Our research confirmed that the majority of third party guarantees are undertaken to support small business, and followed a pattern of male borrowers and female guarantors. Women who guaranteed business loans in our study were generally uninvolved in the operation of the business.
2.29 Guarantees undertaken for business purposes, or mixed business and consumer purposes, are not covered by the provisions of the Consumer Credit Code. Our research indicates that the largest area of guaranteed loans is subject to the least legal regulation.
FOOTNOTES
1. Royal Bank of Scotland v Etridge (No 2) [2002] 2 AC 773, per Lord Nicholls at para 34.
2. Garcia v National Australia Bank Ltd (1998) 194 CLR 395, per Kirby J at para 65.
3. Joe Hockey, “Comment: National Small Business Survey Results” National Business Bulletin January 2003 at 53. The 12th National Small Business Survey estimates that around 60% of small businesses are family businesses.
4. Kosmas Smyrnios, Claudio Romano and George Tanewski, The Australian Family and Private Business Survey 1997 (Monash University, 1997).
5. While 19% of family businesses had a single family member director, 52.8% comprised two family member directors, 14.2 % had three family directors and 10.6 % comprised four or more family members as directors.
6. Other research on the composition of businesses found that family-owned businesses account for 83% of all businesses; and of that 83%, 79.9% are private companies. 47% of those companies have 2 shareholders, 32.6% have between 3 to 5 shareholders, 9.2% have between 6 to 10 shareholders and the remaining 4.4% have more than 10 shareholders; see Price Waterhouse/Commonwealth Bank Family Business Survey of 5000 businesses (1995) 11 Company Director 20, cited in Peta Spender, “Women and the Epistemology of Corporations Law” (1995) 6 Legal Education Review 195 at 197, 202, footnote 24.
7. Kosmas Smyrnios, Claudio Romano and George Tanewski, The Australian Family and Private Business Survey 1997 (Monash University 1997); and CPA Australia, Submission to the Senate Employment, Workplace Relations and Education References Committee: Inquiry into Small Business Employment Issues (16 May 2002) at 7-8.
8. Kosmas Smyrnios, Claudio Romano and George Tanewski, The Australian Family and Private Business Survey 1997 (Monash University, 1997) at 19.
9. Kosmas Smyrnios, Claudio Romano and George Tanewski, “Capital Structure Decision Making: A Model for Family Business” (2000) 16 Journal of Business Venturing 285 at 303, 304.
10. Guarantor Survey, Question 24(b): around 33% of those who guaranteed a business loan for someone else lost their home as a result.
11. The issue of benefit is discussed in further detail in Chapter 7: Litigation.
12. See Radmila Jukic, Till Debt do us Part (Consumer Credit Legal Service, 1994) at 23-24.
13. See Kathy Marshack, “Copreneurs and dual-career couples: Are they different?” (1994) 19 Entrepreneurship Theory and Practice 49.
14. Supriya Singh found that 12.8% of married people with joint accounts did not know their total household income and 16.3% did not have any information on their bank deposits. Singh concluded that “anywhere between 13% and 16% of persons with joint accounts could not exercise joint control, or even any control over their money”. Supriya Singh, Marriage Money: The Social Shaping of Money in Marriage and Banking (Allen and Unwin, Sydney, 1997) at 87 and 108. See also Meredith Edwards, “Individual Equity and Social Policy” in Jacqueline Goodnow and Carole Pateman (eds), Women, Social Science and Public Policy (Allen and Unwin, 1985).
15. See Supriya Singh, For Love Not Money: Women, Information and the Family Business (Consumer Advocacy and Financial Counselling Association of Victoria Inc, 1995).
16. Belinda Fehlberg, Sexually Transmitted Debt: Surety Experience and English Law (Clarendon Press, 1997).
17. See Belinda Fehlberg, “Women in ‘Family’ Companies” (1997) 15 Companies and Securities Law Journal 348 at 360.
18. See Belinda Fehlberg, “Women in ‘Family’ Companies” (1997) 15 Companies and Securities Law Journal 348 at 360.
19. This may be because of the sampling process of the Australian study. The sample was chosen randomly using the Yellow Pages business directory, and so women were more likely to be directly involved in the business: see Supriya Singh, For Love Not Money: Women, Information and the Family Business (Consumer Advocacy and Financial Counselling Association of Victoria Inc, 1995) at 19-20.
20. Belinda Fehlberg, “Women in ‘Family” Companies” (1997) 15 Companies and Securities Law Journal 348 at 364.
21. See Kate Keating, “Relationship Debt” (2000) 2 Butterworths Consumer Credit Bulletin 3 at 4.
22. Research in the USA has revealed that personal and professional lives of women in family businesses are dominated by interactions with other family members, to the detriment of other participation in external networks such as friendships or support groups. While there is a suggestion that family businesses may be more “family friendly” for women, family businesses are extensions of a family’s culture, dynamics and biases. This may mean that the role of some women in family businesses may be traditional and limiting. See, for example, Barbara Hollander and Wendi Bukowitz, “Women, Family Culture and Family Business” (1990) 3 Family Business Review 139.
23. Belinda Fehlberg, Sexually Transmitted Debt: Surety Experience and English Law (Clarendon Press, 1997) at 89.
24. Belinda Fehlberg, “Women in ‘Family’ Companies” (1997) 15 Companies and Securities Law Journal 348 at 364. See also Kristie Dunn, “Yakking Giants: Equality Discourse in the High Court” (2000) 24 Melbourne University Law Review 427, in particular at 447–454.
25. Gough v Commonwealth Bank of Australia (1994) ASC 56-270 per Kirby P.
26. Belinda Fehlberg, Sexually Transmitted Debt: Surety Experience and English Law (Clarendon Press, 1997) at 138. Fehlberg also noted a distinct trend for women who were “involved” to work for the business either unpaid or paid at just below the tax threshold: at 140.
27. Of the remaining 18%, most were partners in a partnership arrangement. Guarantor Survey, Question 31.
28. 38 % of barristers and 31% of solicitors reported that in the last guarantee matter on which they acted, the loan was valued at between $50,000 and $250,000, while 18% of barristers and 25% of solicitors reported loans between $250,000 and $500,000 in their last matter, and 38% of barristers and 22% of solicitors reported loans over $500,000: Barrister Survey, Question 10(b), Solicitor Survey Q11(b).
29. In the case review only 2% of matters involved a loan of less than $50,000, 38% concerned a loan between $50,000 and $250,00, 25% were between $250,000 and $500,000 and 35% were over $500,000.
30. Belinda Fehlberg, Sexually Transmitted Debt: Surety Experience and English Law (Clarendon Press, 1997) at 163.
31. Belinda Fehlberg, Sexually Transmitted Debt: Surety Experience and English Law (Clarendon Press, 1997) at 164.
32. Consumer Credit Code s 6.
33. Consumer Credit (New South Wales) Act 1995 and Regulations.
34. New South Wales Law Reform Commission, Guaranteeing Someone Else’s Debts (Issues Paper 17, 2000) at 6-7.
35. NSW Legal Aid Commission, Submission at 2-3.
36. Ryde-Eastwood Financial Counselling Service, Submission at 3.
37. Women’s Legal Resources Centre, Submission at 3.
38. Report of the Expert Group on Family Financial Vulnerability, Good Relations, High Risks: Financial Transactions Within Families and Between Friends (Report, 1996) at 38.
39. New South Wales Law Reform Commission, Guaranteeing Someone Else’s Debts (Issues Paper 17, 2000) at 7 and 100.
40. Belinda Fehlberg, “Money and Marriage: Sexually Transmitted Debt in England” (1997) 11 International Journal of Law, Policy and the Family 320 at 340.
