If you have ever wondered what contingent liability is and whether you can be held liable for it, this article was drafted with you in mind, writes financial planner Pieter Willem Moolman.
A contingent liability – a vital part of business assurance – is a potential liability that arises from a past transaction and is dependent on one or more uncertain future events, such as death.
Examples of contingent liabilities are endless and could include financial disputes or being held jointly and severally liable for a suretyship agreement.
The credit policies of South African banks and other financial institutions often require business owners to sign surety as part of their application for external funding. External funding is a normal part of any business and is acquired on a daily basis.
However, when business partners are asked to sign surety on behalf of the business, they immediately expose their estates to being held liable for the debt of the business. This is when the need for contingent liability insurance arises.
In practice, the business takes out cover on the life of a business partner for an amount that will – after income tax, estate duty and capital gains tax – be equal to the amount for which that partner stood surety.
The partners usually enter into an agreement with the business in which they agree that, in event of death, the lump sum payment received from their life cover will be used to settle the liability for which they stood surety. This solution could also be extended to include disability.
This insurance solution is designed to protect the deceased or disabled partner’s estate against creditors. The partner is then released from his or her duty as surety and the surviving spouse and relatives are not burdened with potential claims against the estate for the debt of the business.
It is important to remember that the life insurance policy must be taken out over the life of a business partner and must be funded by the business.
The payment received from the life policy may not be paid to the deceased’s estate or beneficiaries. It is only due and payable to the company to settle debts for which the deceased could be held liable.
Contact your financial planner to discuss contingent liability insurance with you and your business partners, and protect surviving relatives from having to settle creditors’ claims from your estate.