3rd Oct 2014
Clients often come to us and ask what can they do to protect their private assets from the debts and liabilities of their business. Incorporation in the form of a corporation, limited liability company, or for some a limited liability partnership is the basic building block of an asset protection strategy. Using one of these corporate entities is a great step, but it is a step that must be done right. Legal scholars like to talk about the corporate entity as a veil: a thin layer that separates the business owner’s personal assets from the business liabilities.
Here is the fictional story of Mr. Brown. Mr. Brown owned a chain of indoor inflatables fun centers. He set up Funny Bounce, LLC with his attorney Mr. Jones. Several years down the road, Mr. Brown is being sued due to an accident in one of his fun centers. A child was injured when an inflatable deflated trapping the child inside the large structure. It is questionable whether the fun center or manufacturer is at fault. The lawsuit names Funny Bounce, LLC and Mr. Brown individually as defendants. Mr. Brown wants to know, will the LLC protect me? Mr. Jones finds out that while the LLC was created, Mr. Brown has never transferred any of his equipment into the LLC. Checks to the business are written to Mr. Brown individually. Mr. Brown never started a bank account for the business and runs all the money through his private account. Mr. Brown isn’t even sure he ever filed a tax return for the business separate from his own. Mr. Jones has the sad task of telling Mr. Brown that it is likely the LLC will not protect him.
Why? Separation of personal and business assets is the next step in establishing liability protection that Mr. Brown failed to take. Once you have the corporate entity, it must be used. All things, assets, income, debts, contracts, must be with or flow through the business. The business must be treated as its own entity separate from the owners or else people suing you will be able to “pierce the veil” and get through the layer of corporate protection to the personal assets of the owners.
There are certain types of liabilities that can always go through the corporate veil that business owners should be aware of so these can be managed. The first are trust fund liabilities. These are the funds the employer collects from its employees to be paid to the IRS, Social Security, Medicare, etc. Employers hold those funds in trust. If a business fails to pay those funds to the proper agency (and instead uses them for cash flow, for example), the owners of the business and any person with financial authority over the business can be personally liable for repayment. Criminal acts are another potential source of individual liability. If you overbill Medicare, you will owe the money personally. If your company forges food inspection records (see the recent Peanut Corporation convictions), you can be personally liable for the damages and fines. A final area to be aware of, although it is sometimes unavoidable, is personal guarantees made on business loans. Up to the amount of the guarantee, your personal assets can be placed at risk. All of these risks are manageable and in the case of trust fund monies and criminal acts, completely within the control of the business owner.
Using a corporate entity is almost always the best step number one. Keeping assets separate is a must. Possible use of an asset protection trust, transfer of family wealth, and using insurance as an added protection are other weapons in the arsenal to consider. You should consult with your attorney and financial advisors as to the next steps.