By Robert J. Silverman, Attorney at Law
We live in a world that loves to litigate. Protecting yourself and your assets is therefore of the utmost importance. As this blog post will explore, insurance coverage helps, but you should consider the limited liability benefits of forming a business entity – especially if you own any investment property or small businesses.
Think of insurance coverage as the foundation of your protection, but remember that the four walls protecting you from the litigious outside will be the incorporation of your assets into a business entity.
In our litigious society, a fear of lawsuits is prevalent and understandable. People are always at risk of committing negligent acts and omissions that cause, or allegedly cause, harm to others. Of course, a much bigger problem arises when the person who is alleged to have committed such negligent act or omission has no applicable insurance coverage.
Many people, including knowledgeable professionals and business owners, are not well informed about detailed aspects of their property and casualty (P&C) insurance coverage. I encourage you to have detailed discussions with your P&C insurance agent about whether or not you have personal and business policies containing: a) appropriately broad scope of coverage for the areas in which you have risk; b) reasonably high coverage limits; c) optimal deductibles; and d) umbrella coverage under which you cost-effectively boost your limits.
The challenge is that even people who have terrific insurance policies have some risk because every insurance policy contains exclusions. Thus, everyone, particularly those who own a small business or a real estate investment property, has gaps in protection. Such people are exposed to unlimited liability for claims, lawsuits, and damages that may arise out of such business or real estate investment venture. If someone files suit and obtains a judgment against the owner of such business or investment property, the owner’s personal and other (unrelated) business assets are vulnerable – available to satisfy the judgment.
One can go a long way toward filling these protection gaps by forming one or more business entities, such as a limited liability company (LLC) or corporation. By properly forming, capitalizing, and operating an LLC or corporation in connection with a business or investment property, the owner is legally entitled to limited liability. This means that a potential judgment creditor can only obtain a judgment against the LLC or corporation; not the owner. Consequently, the only assets available to satisfy such potential judgment are those owned by the LLC (i.e. not the owner’s personal or unrelated investment assets).
Suppose that someone who prudently owns his business or property in a LLC or corporation is sued and the claim isn’t covered by insurance. What can the owner do? In a hypothetical situation, a client contacts me to inform me that two employees of his small mortgage business had sued his corporation and sued him personally, claiming sexual harassment. The client said these former employees had been “bad apples” and that there was no basis for the lawsuit. Nevertheless, the client is worried about what some jury might be led to believe and asks me if I could help him: i) immediately form a business entity for his apartment building; and ii) transfer substantially all of his assets to a close relative. The client naturally wanted to protect his assets so that they would not be available to these employees if they happened to win their lawsuit and be ordered to pay a large damage award.
I would first suggest that he check with his business insurance agent to see if he might have applicable insurance coverage. Unfortunately, most business policies (“General Liability”) exclude or contain very limited coverage for sexual harassment claims; and only special policies – that only a small percentage of business owners purchase (“Employment Practices Liability Insurance”) – include relevant coverage.
Next, I would warn that there was a whole body of (complex) law dealing with “fraudulent conveyances” that would render ineffective the transfer of all or most of his assets out of his name. Essentially, these laws prevent people from effectively thwarting known or anticipated creditors from collecting a judgment if such transfer renders the alleged wrongdoer insolvent.
The “bottom line” is that it is critical to employ asset protection strategies before a problem arises. One should consult with an insurance professional and/or an attorney in advance of any claims or threatened claims. At that point, it’s possible to create viable protection by taking various asset protection measures. Some of these include: purchasing optimal insurance, forming one or more business entities, creating trusts for the benefit of loved ones containing spendthrift provisions, and sheltering assets, as appropriate, in highly creditor-protected vehicles, such as 401Ks, IRAs, and life insurance.
As the old saying goes, if you fail to plan, you are planning to fail!
This article is intended to provide information of a general nature, and should not be relied upon as legal, tax, financial and/or business advice. Readers should obtain and rely upon specific advice only from their own qualified professional advisors. This communication is not intended or written to be used, for the purpose of: i) avoiding penalties under the Internal Revenue Code; or ii) promoting, marketing, or recommending to another party any matters addressed herein.
ESTATE & TRUST ADMINISTRATION: Need to find an experienced estate & trust administrator in Walnut Creek CA? Contact Robert Silverman at 925-705-4474 for legal advice on a Revocable Living Trust, “Summary” Estate Administration, Trust/Estate Beneficiary Representation and Will & Trust Disputes.