The entrepreneur often depends on his business to search for life. Get paid to support yourself, your family, and even your quality of life. For this reason, it is imperative to make sure that your business is protected from external attack by creditors. After all, let’s say, an attack on the business is the same as an attack on the individual.
Therefore, it is extremely important (1) to incorporate the company with the appropriate legal entity; (2) manage risks from the business itself; and (3) respect the legal personality and legal independence of the business.
There are numerous entities that provide limited liability. In particular, the limited liability company (“LLC”), the corporation, and the limited partnership are those that limit liability. This means that the partners (or members in the case of the LLC), just by virtue of being a partner (or member), are not personally liable for the debts, obligations, or responsibilities of the business.
In essence, the aforementioned entities, before the law, already have strong principles of asset protection incorporated. This is due to their classification as persons before the law, that is, legal persons, which are completely independent and separate from the partners (or members). Why would you answer for someone else’s debts? In other words, the limited liability company, corporation, and limited partnership consist of a presumption of separation between the interests and property of the partners and those of the company. However, this separation has to be respected to enjoy limited liability.
When a creditor comes into view, the business assets may be in jeopardy. For example:
If Restaurant A obtains a loan, is then in default, and is not able to repay it in the end, the Bank Lender will consider the business assets as an available resource to update the borrower. In this way, the Lender Bank could use the kitchen equipment, sell it, and apply the proceeds to the loan. (Please note that if you had established a guarantor of the loan for Restaurant A, the Bank Lender could compel you to respond personally for the default of the payment.)
In this example, kitchen equipment is nothing more than a spoke on a wheel full of assets. Businesses are made up of many moving parts, such as accounts receivable, intellectual property, manufacturing equipment, the property itself and its land, employees, investment property, and so on. For this reason, it would not be prudent to keep all assets within a single entity because the creditor, with certain exceptions, would have the opportunity to seize and collect any of them to liquidate the debt of the business.
Additionally, a single asset (the risky asset) can put others at risk and subject them to creditor claims. This generally occurs with employees and investment properties; they are very risky assets. As a separate point, note that the United States is a litigation company that, along with result-oriented judges and juries, has awarded high damages to the plaintiff. Therefore, separating risky and non-risky assets from business, and rather separating high-risk assets from others, is the kind of preventive planning of asset protection essential for survival.
One way (and there are others) to carry out the above is to set up different entities that serve to isolate high-responsibility assets – like employees – from others. In this scenario, an operating entity is created, which manages the day-to-day affairs of the company, and other holding entities , which serve to own the risky assets and lease them back to the operating entity.
Obviously, the responsibility for the commercial activity falls on the operating entity. The holding entity , on the other hand, is not liable for the debts, obligations, or responsibilities of the operating entity. This is because said entity has its own legal personality, is considered separate and independent from the operating entity, and above all, is not linked to its risky commercial activities.
In addition, the lease fees paid to the holding entity by the operating entity serve to remove cash from the operating entity. In this way, the profits of the operating entity will be channeled to the different holding entities , and most likely, protected from the creditors of the main business, or operating entity.
Respect legal personality
The effectiveness of the asset protection plan for your business is highly dependent on you. As already indicated, it is essential to respect the legal personality and legal independence of the same. In other words, you cannot treat society as if it were your personal bank account or mix your funds with those of your business. Doing this degrades the advantage of the separate legal entity (by not respecting the legal personality) and almost ensures that you will personally answer for the debts, obligations, and responsibilities of the business.
Remember, debt that remains unpaid will draw the attention of creditors. If the company does not have the resources to pay it, then, the creditor could seize and collect its assets (see “Risk Management”). However, if you manage the business not as a business but rather as a mere facade of yourself, or alter ego , the creditor could personally attack you. In such a case, the creditor could lift the veil (legal terminology to hold you responsible for business debt) under various theories.
One such theory is the so-called noncompliance with business formalities, such as not documenting transactions. Another theory, as already mentioned above, is to prove that the partners or members of the business administered it without consideration and respect for their legal personality, such that a merger of the two emerged – both entity and owner – and therefore should be treated as a single entity.
I repeat: there is no one size fits all asset protection plan . What works well for one business may not be right for another business. Keep in mind that what would serve everyone in terms of the general protection of your business will be doing your errands and buying insurance. However, talking to a lawyer, discussing options, and learning the same should be the priority.