Avoiding Day-to-Day Liability Risks
Traditionally, business owners have relied on how-to guides that offer instruction limited to the process of forming the business entity.
Unfortunately, the mere formation of an LLC or a corporation is not, in itself, a sufficient asset protection strategy. Asset protection planning requires that the business be structured and funded to eliminate personal and business liability. These issues are addressed in the section titled, "Limit Liability in Your Business Structure."
However, the formation of an LLC or a corporation is not a sufficient asset protection strategy, even when the entity is structured and funded to avoid personal and business liability. The entity must also be operated in ways that preserve the owner's limited liability and, thus, protect the owner's personal assets outside of the entity as well as the business's assets (the owner's investment in the business). All of this is achievable with the strategies advocated in this part on the Toolkit's asset protection module.
- Withdrawing Funds from the Business is, in essence, a complement to the structuring and funding strategies presented when using operating and holding companies. The business entity must be structured and funded strategically, to minimize the amount of vulnerable capital invested within the business form. In this way, the business's assets, which face the highest risk of loss, are protected, along with the owner's personal assets outside of the business form.
The withdrawal strategies illustrated there ensure that vulnerable funds are withdrawn from the business entity as they are generated. Without withdrawal strategies, vulnerable funds would accumulate in the business entity, defeating the very purpose of the structuring and funding strategies previously implemented.
This discussion presents the advantages and disadvantages of alternative withdrawal strategies, including distributions of earnings and payments to the owners for salary, loans and leases, with a special emphasis on the effect that fraudulent transfer restrictions and the self-employment tax have on these withdrawal methods. The discussion also examines the interrelationship between the fraudulent transfer restrictions imposed by state LLC and corporation statutes, and the restrictions imposed under the Uniform Fraudulent Transfers Act.
Finally, this underscores the importance of authorizations and documentation when withdrawing funds from the business entity.
- Limiting Liability for Contracts and Torts explains the significant exceptions to the limited liability for owners of an LLC or a corporation, with respect to the business entity's debts. If an exception applies, unlimited personal liability for the business entity's debts is imposed on the owners. When this occurs, the very purpose for which an LLC or a corporation is created--limited liability--is lost.
Because business owners, typically, are unaware of these exceptions, the objective of this section is identification of the specific exceptions, both in terms of the entity's contracts and any torts (e.g., negligence) committed by the entity's employees. With this knowledge, and the strategies presented in our discussion, business owners can avoid these exceptions and, thus, preserve their limited liability for the business's debts.
- Piercing the Veil of Limited Liability examines another important exception to limited liability--the concept of creditors "piercing the veil of limited liability" through what are termed the alter ego theory or the undercapitalization theory.
Clearly, if either theory is applicable, the owners of the business will suffer unlimited personal liability for the business's debts, and the very essence of the LLC or corporation (limited liability) will be destroyed. This section examines the nature of these two theories and the strategies that can ensure neither theory will be applied to the business.
- Navigating the Court System identifies aspects of the court system, itself, that are significant risk factors for business owners. Yet, through an understanding of how the court system heightens the risk of loss, and how to use the strategies presented in this section, business owners can control the court system and, thus, significantly reduce their overall exposure to liability.
- Insurance--The Protection of Last Resort explains the ins and outs of your last line of defense in asset protection. Ideally, the small business owner will structure his financial affairs so that claims will not be made or, if claims occur, the claimants will be unable to satisfy their claims from the business owner's personal or business assets. The asset protection strategies advocated throughout this entire module are based on these principles.
Occasionally, however, claims will be made. Some of these claims may penetrate the layers of protection set up by the business owner. If this occurs, one last layer of protection still should be ready to defend the business owner--insurance.
This section describes the nature of liability and property insurance in general, and the specific types of individual liability and property polices appropriate for business owners. Emphasis is placed on understanding and planning for coverage and exclusion issues that arise in each type of policy. This discussion also covers important points that arise when business owners deal with insurance companies on claims, including notification rules, the duty to defend clause and the use of bad faith claims against insurance companies.
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