The following is some good advice on how you can use multiple entities to protect yourself in the case of a lawsuit.
Using Multiple Operating Businesses
If the function of the business can be separated into multiple operating entities, their assets and the separate operating entities themselves can then be more easily protected. For example, a group of investors might use three separate LP’s co own three medical clinics in different locations and three separate corporations to operate the three medical clinics. If something happens at one of the clinics, giving rise to potential liability, the assets of all the separate clinics could be protected from the claim against the one.
Take for example a lumber yard that was divided into three separate operating businesses – the retail score, the trust company, and the trucking operation. Because each company was run independently from each other, the liabilities associated with operating trucks and the liabilities of manufacturing trusses would not create a liability for the retail establishment. This strategy is also useful for a company that manufactures or wholesales different produce lines. Whenever a particular produce creates high liability, using multiple entities is an effective technique for insulating each separate produce from liability caused by another.
Business Real Estate
Assets, such as real estate and equipment should seldom, if ever, be held by the operating business. These assets should generally be held by another entity – a Family Limited Partnership, a LLC, or a trust – and leased back to the corporation at a reasonable rate. Since the property will be leased rather than owned, the assets will not be available for seizure by a creditor of the operating business.
The written lease between the operating entity and the asset owning entity is critical. Most asset protection advisors suggest that their clients structure the lease so that all liability flows to the tenant. The operating business (which has very little net worth) then has the responsibility to maintain the premises, provide maintenance and repairs, insure the property, and defend in the case of a lawsuit. The lease identifies the lessee as being solely responsible for making the real estate safe and usable by all who come on the premises.
For example, a woman who had tripped and fractured her hip was awarded $600,000 in a suit against those responsible for the office building where she was injured. The court then had to decide who should be required to pay those damages. The owner of the building was absolved of responsibility because the property had been leased under a tightly drawn agreement that made the lessee responsible for the maintenance of the property, and also provided that in the event of any legal action, the lessee would have to indentify the owner.
The operating company should rarely hold surplus cash. Generally, only amounts necessary to pay immediate and foreseeable obligations should remain in the corporate accounts. Any surplus could be loaned or paid out as salary or some other type of distribution. Keeping large amounts of cash in the operating company is considered to be an extremely poor asset protection strategy.
When considering the amount of cash to keep in the corporate account, owners must also be concerned about state specific minimum capitalization requirements. Capitalization refers to the amount of money and other assets you and your cofounders invested in your corporation. lf you incorporate, be aware that your state might be one of the remaining states to have formal minimum capitalization requirements. For example, California requires a Corporation that serves as a general partner of a Limited Partnership to have a minimum of $100,000 in liquid assets. Inadequate capitalization may be viewed negatively by the courts when a creditor, plaintiff or the IRS is seeking to pierce the corporate veil to get at the assets of your corporations directors, officers and/or shareholders.
Inventory & Accounts Receivable
Inventory almost always needs to be owned by the operating company. This allows the company to buy and sell inventory without complicated agreements between other entities and the problematical tax implications such arrangements would create. If these types of assets are significant in value, one solution is to create Liens which will have priority over subsequent creditors. For example, most retail outlets purchase their inventory on payment terms such as “net 10” or “net 30” which allows the business a few days to pay for their merchandise. Purchasing inventory “on terms” creates a claim against the value of the inventory. If the pizza restaurant previously mentioned carried about two weeks of inventory, yet had arranged with their vendors 15 days to pay for all their purchases, the inventory susceptible to a lawsuit would be negligible.
In addition, the owners of a business or professional practice can make advances to the operating company for working capital and other needs. As security for these loans, the corporation could give the owners a lien, as collateral, on corporate inventory and receivables. This security interest is called a UCC-1 filing under the provisions of the Uniform Commercial Code (UCC) The desired result of this UCC-1 filing is that the inventory and receivables will be protected. A judgment creditor would find that the equity in these assets is subject to the superior claim of
the business owners and cannot generally be used to satisfy the judgment.
The majority of the information in this post came from the book “The Asset Protection Bible”, if you are curious in getting a copy let me know.
– Matt, Legally Mine
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