Using Limited Liability Companies or Partnerships to Protect Assets
Corporations date back to the Dutch East India Company as a structure for investors to share the rewards and risks of business ventures without risking anything beyond their actual investment. In addition to being a way to raise money and centralize management of businesses, corporations limit liability since claims against the corporation for debts and injuries do not flow back to the shareholders. Only the corporate holdings are at risk, not the other property of its owners.
This is distinguished from a sole proprietorship. If, for instance, you own a rental property in your own name, fail to shovel the walk after a snowstorm and someone falls and hurts himself, he can sue you personally for his injuries and seek recovery against all of your assets, not just the rental property. If, however, the property were held in a corporation, the injured party could only seek recovery against the corporate assets, presumably just the building itself and a bank account maintained for operating expenses.
New Forms of Corporate Ownership
Since corporations are formal entities and somewhat cumbersome and expensive to manage, recent decades have seen a proliferation of other limited liability business forms, each with its own acronym and features, including limited liability partnerships (LLPs), professional corporations (PCs), and limited liability corporations (LLCs). While each entity is a bit different and they differ from state-to-state, all these corporate forms have the following in common:
- They permit multiple owners.
- One or more owners may be named to manage the business.
- Liability for corporate actions extends only to the entity’s assets, not those of its owners.
To determine which form of business best fits your needs, you will need to consult with a local corporate attorney.
Each Boat in its Own Corporation
Often landlords who own multiple buildings have them each owned by a separate corporation or partnership. That way, if anyone sues due to an injury occurring at one building, the other properties will not be at risk. Other business may follow the same strategy:
When I was in law school, I spent a summer working at a large New York City law firm that had a specialty in bankruptcy. I was assigned to work on the bankruptcy of a shipping company that owned several old freighters that sailed up and down the east coasts of North and South America. It turned out that each ship was owned by a separate corporate entity, meaning that we had to prepare separate filings for each ship. Unfortunately in terms of our workload, this was before the days of word processing, so we couldn’t simply copy and paste. One of the biggest immediate problems for the company was that one ship full of ripe bananas was just off the port of Galveston. The company couldn’t afford to pay the dock fees and was also concerned that if the ships did come into port they would be seized by its creditors. As the week went on, the bananas began to rot. In addition, there was concern that it and other ships would run out of fuel to run their bilge pumps, potentially resulting in their sinking. As part of the bankruptcy process, the company was permitted to use its cash on hand to keep the ships afloat rather than pay it to creditors. (Of course, they were also permitted to pay their attorneys.)
Follow the Rules or Risk Losing the Protection
One caveat to be aware of if you choose to use any of these corporate forms for purposes of limiting liability: You will need to follow all of the formalities required by law, whether that includes annual filings with the state, notices to shareholders, or annual meetings. Otherwise, you could lose the benefit of the protections provided by the limited liability structure. If your corporate entity is sued, the plaintiff may seek to “pierce the corporate veil” by showing that despite the incorporation, you treated the business as if it were a sole proprietorship. If the plaintiff is successful, all of your property could be at risk. As an example, if you were to place rental property in a corporation or partnership, make sure that the tenants make their checks out to the company, not to you personally. And make sure that you deposit the checks into an account in the corporation or partnership’s name, not your own bank account. Run all of the expenses through the business account and file a separate income tax return for the business each year.