How to DOUBLE the Asset Protection
of your Business and Personal Assets
Watch the VIDEO here
When you think about it, keeping your money is at least as important as making it. If you don’t protect it, somebody is going to take it away from you. So it always surprised me when I see so many successful business owners and entrepreneurs who are running their businesses as sole proprietorships and having rental properties in their own names. Look at protecting your financial assets the way you do your physical assets. You’ve probably got a security system at your home that you pay for every month, you’ve put up fences and lights to keep thieves out and you probably have security cameras. You’ve done everything you can to keep a thief from taking your property. But the truth is, most business owners have a better chance today of losing money in a legal or financial attack than from a burglar. So why not make fortify the protection of your business like you do with your home? Will legal and financial attackers come after you if you’ve got legal protection, when there are a lot of people who don’t have any protection? The odds are much lower, and if they did, they’d run into legal obstacles that might make them wish they hadn’t tried.
Asset Protection Basics
First of all, you need to understand some of the basic asset protection tools an attorney has available to use for your protection. Corporations, limited liability companies (LLC), limited partnerships, trusts, benefit plans, retirement plans, and even contracts can be used as asset protection tools and the tools can be used in conjunction with each other. On the other hand, it’s usually best to keep it as simple as possible. There are plenty of advisors and attorneys that try to “set you up” with layer after layer of asset protection. They use the common tools and stack them on top of each other. The feeling is that if one is good, ten is better. Usually, the push for complexity is just a way for the asset protection firm to make more money.
Traditional and DOUBLE Asset Protection
Corporations were created to protect the investors (stockholders) and managers (officers and directors) from liabilities that might occur because the corporation was doing business. Corporations were NOT created to protect your stock in the corporation from being taken away from you when YOU get sued personally or have big problems. We’ll be talking about this “DOUBLE Asset Protection” later in depth. I’d like to thank Lee R. Phillips, JD, a Court Counsellor to the US Supreme Court, who has been the leading advocate for “Double Asset Protection.” But let’s first let’s talk about Traditional Asset protection before we get into “the good stuff.”
Traditional Asset Protection: “The Corporate Shield”
Congress created corporate protection to encourage people to fund and run companies. If you take the risk of starting your small business, or if you invest in someone else’s company, Congress has agreed to protect your personal assets from disastrous events. But the business entity you create for your small business is different than the Wall Street companies. When you set up a corporation or LLC, you own it alone or maybe with another person or two it is a “closely held company” which means the courts will look at it very carefully to make sure you treat it as a real “corporate entity” rather than just your “alter ego.”
Technically, the legal structure is the same as the big corporations, but the care and feeding of your closely held company feels very different. The laws won’t protect you from everything that happens in the business, unless everything associated with the corporate structure and maintenance is done just right. Most asset protection for “closely held companies” fail when they are really challenged. Corporations and LLCs are often lacking when set up, and even if they are set up well, they are seldom “managed” correctly. There are 16 main “corporate formalities” you have to do routinely in order to ensure that your corporation or LLC will actually protect you when there is a problem. The fact is a high percentage (well over 50%) of the corporations in the United States will not protect the officers and directors, because the owners haven’t followed the formalities. In your corporation you will not only be a shareholder, you will be an officer (president) and director of the company. That means you may be exposed to a lot more liabilities than the Average Joe shareholder of a big corporation, because if somebody can “pierce the corporate veil,” it is the officers and directors who become liable. So with all that liability exposure, you can see how important following these “formalities: are.
So, what happens when you are doing business as your corporation or LLC, and you get sued? The Plaintiff will always sue your corporation or LLC… and YOU. When you get to court, you’ll no doubt ask the judge to dismiss the suit against you personally. The judge start down the list of formalities the corporation must follow. If you can’t establish that you have followed the formalities, then he will simply say how sorry he is that he can’t use the corporation to protect you. He will have no choice but to “pierce the corporate veil” of your corporation or LLC and allow you to be personally liable for the misdeeds/mistakes of the corporation/LLC. That means your home, your car, your bank accounts, can all be used to pay the Plaintiffs if they win.
Personal Liability, or “Back Door Liability” for Your Business Entity
What happens to your company when you get divorced or one of your company co-owners gets divorced, is sued, goes bankrupt, or suffers some other “personal disaster”? How do the personal disasters of one shareholder/member affect the other shareholders/members? It’s likely none of your advisors have ever discussed these issues with you. Until now. Yes, there is another universe of asset protection independent of the corporate shield world, and you should pay attention because the outcome of your personal disasters or those of your business associates will be very different depending on how you structure your company.
Business or corporate activities are occurring out in front of the shield, personal activities are occurring behind the shield. As we’ve been saying, in a corporation – and that includes C-corps, S-corps or LLC – if the attack comes from the company side of the shield, then the people behind the shield are protected as long as the corporate formalities are followed. However, if the attack comes from behind the personal side of the shield, the corporate shield doesn’t protect the individual under attack. Even worse, it also doesn’t protect the company itself (and its assets) or any of the other co-owners of the company from your personal disasters. If you have a successful business, your business is probably your most valuable asset. short, YOUR BUSINESS NEEDS TO BE PROTECTED FROM YOU! And your assets are at risk even if the questionable conduct was done by someone else in your company. Yet Congress has never given us a shield to protect us against our personal problems.
One way to protect yourself against an attack from the back of the shield is to carry a lot of insurance. Look at beefing up your homeowner’s policy, health insurance, and auto insurance. Make sure you have a big umbrella policy. But the problem with insurance is the “coverage.” We know that insurance companies love to limit their coverage, adding tons of exceptions and addendums. When it works, insurance is great. But the insurance company’s job is to get out of paying your claim, so there are lots of holes in insurance coverage. So, if insurance doesn’t fully handle the claim, you will be sued.
Asset Protection for Real Estate Investors
Many real estate investors are advise to hold assets in a land trust, which can make it more difficult for Plaintiffs to find your real estate assets. But if you are attacked personally, the land trust will not give you protection. For asset protection purposes, it is a good idea to hold each property in a separate entity rather than your own name or a land trust. Obviously, there is a limit to the number of entities you can afford and manage, as most people can’t effectively manage any more than 3 to 6 entities. If you have a lot of properties, logically group them into a limited number of entities. The question is what entity should you use to hold the properties?
If a tenant slips and falls, the tenant will have to sue the entity that owns the building. This attack is coming from the front (company) side of the shield. Assuming the corporate/LLC shield holds, the most the tenant can get is the assets of the entity that owns the building. Your other assets, including your ownership of the entity that owns the other apartment building, will be safe. So a corporation will do just fine.
But what happens if the attack comes from the back (personal) side of the shield against you or one of the other owners of the corporation? If the attack is successful, the spoils of the suit may well include your stock in your close corporation. The creditor now has voting rights and could throw you out as officer and director, elect new officers and directors (himself), and he now runs the show. You not only lost money and assets, you’ve lost your own company.
Now, what if your entity was an LLC? The creditor will also get your membership interests in the LLC, but with a properly drafted LLC Operating Agreement (like we do at Simone Legal PC) the creditor cannot take over control. When the creditor gets a membership interest in an LLC the creditor must get what is called a “charging order” to come against the entity. The charging order limits the creditor to only being able to receive the financial benefit of the owner’s interest in the LLC or limited partnership. This is very different from being able to seize the stock in a corporation and have all the voting rights and management rights. If the LLC document is written properly, the management of the LLC is intact and free from the creditor’s influence. In fact, the managers of the LLC can basically make life miserable for the new member! You can siphon off all the income and tax benefits before the creditor gets anything, and in some cases, you even can shift tax burdens to the creditor.
The bottom line is that using the LLC structure you still have control of your company even after losing the lawsuit, but if your entity was set up as a Corporation, you’d have nothing. That’s a very different outcome.
How To Get Charging Order Protection?
Obviously, you need to consider an LLC as the basis for your business structure. But that’s just the beginning. When you set up an LLC, the Articles of Organization are simply the papers the state requires. The operating agreement is something many people forget about, or you might get the a generic “boilerplate” version online or from an attorney. However, the operating agreement is critical, because you basically get to define what charging order protection you’ll get out of your LLC. If you write your operating agreement with the nuggets that beef up charging order protection, the courts will honor those documents in almost every situation. For example, if the operating agreement says that no distributions will be made to an “assignee” or “transferee” of a member’s interest, most courts will honor that. You may have just eliminated the creditor’s possibility of ever getting a distribution of profit. Without the possibility for a distribution, the economic interest the creditor gets is worthless.
These types of little changes in an operating agreement make a huge difference. Most attorneys and websites never address these issues. Your advisors have probably never thought much about charging order protection, but you need to. The charging order aspect of LLCs is one of your most powerful asset protection strategies. Learn how to use them, and you can sleep a lot better at night, because your assets are protected from the business liabilities and many of your personal liabilities. This means you can get protection from both the front and the back side of your shield.
If You Want Asset Protection, Do Not Wait.
If you are already in trouble, basically your asset protection options are nonexistent. That’s why you do your asset protection planning NOW before the problems arise. All states have “fraudulent conveyance laws,” which look back at transfers from two to seven years. If you move assets for less than fair market value (give them to the kids or another creditor), the courts can use the fraudulent conveyance laws to get the assets back.
However, if you put the properties into an LLC and get membership interests back in exchange, then there might be a very different story. There won’t be fraudulent conveyance, because you get equal value worth of membership interests back in exchange for the property you put into the LLC. You’re just changing the nature of the asset. With your other properties in the LLC, when the judgment comes, the creditor must get a charging order, which limits his remedies. All the creditor gets is a lien against the economic interest represented by the membership interest and that’s all. By law, you have protected your other properties.
Summary
So there you have, you just learned about something that the vast majority of small business owners – and even many attorneys – know nothing about. In short, if Asset Protection is what you’re looking for, then an LLC with a properly-drafted Operating Agreement is what you want. Following the teachings of US Supreme Court Counselor Lee R. Phillips, SIMONE LEGAL PC drafts these “DOUBLE Asset Protection” LLCs on a custom basis. We also offer a “Peace Of Mind Package” that combines the Asset Protecting LLC with a Revocable Living Trust to handle both your Asset Protection and Estate Planning needs in one solid time-proven structure.
