Got Assets? Protect them with an LLC.
Better than any other structure, an LLC can protect itself from its owners' bad fortune. Confused? Let me explain.
As a business owner you’ve probably heard about LLCs (Limited Liability Companies) as a strategy for protecting your personal assets from the liabilities that your business incurs. For example, if someone slips and falls on your business premises, one of your employees gets in a car wreck, or you suffer a credit card data breach, a properly structured and operated LLC should protect your personal assets from being seized to make good on your business’ liability.
So, LLCs do a pretty good job (as good as a corporation in fact) of protecting your personal assets from business liability (something called “Outside Liability”) using its corporate shield feature. Did you know an LLC is also a superior structure for protecting your business assets from personal liability (something known as Inside Liability).
Here’s how Inside Liability works. Suppose you, (or one of your business partners for that matter) gets in a car wreck and injures a personal with lots of income potential – for example a neurosurgeon. The neurosurgeon sues, gets a $10 million judgment, and starts going after your assets.
If your business assets are held in a traditional corporation, things get ugly. The neurosurgeon can seize your shares of the corporation and immediately steps into your shoes as a shareholder. This means that he gets to make decisions on running the corporation including electing (or unelecting) board members, selling assets, declaring dividends, etc. Of course, if you were the majority or only shareholder of the corporation, the neurosurgeon would own the corporation and could operate it or sell it for cash.
A very different scenario plays out if your business assets are held in an LLC. With LLCs, there are no shareholders, instead, the owners are considered “members.” Under the laws on LLCs, the neurosurgeon would not be able to immediately seize your membership interests. Instead, what he would be able to get would be a “Charging Order.” A Charging Order functions like a lien on your membership interest and essentially is a court order requiring the LLC, when it declares distributions, to pay the distribution to the neurosurgeon instead of you. What a charging order DOES NOT do (especially when the Operating Agreement is properly structured) is give the neurosurgeon any management or ownership rights whatsoever in the LLC. All the neurosurgeon gets to do is to wait for distributions to happen (if they ever happen) when he gets to claim them. Of course, meanwhile you, and the other owners if any, get to keep making all the business decisions including (under most circumstances) deciding not to declare any distributions (which means the neurosurgeon-credit gets nothing for his charging order).
Some states allow the holder of a charging order against LLC membership interests to foreclose on the membership interest which means that instead of just having a lien on the interests, the creditor would permanently own it. However, this is often a very bad choice for creditors since properly drafted LLC Operating Agreements always have provisions that prohibit people who take ownership of membership interests without the unanimous consent of the remaining members from exercising any management control of the LLC. In our scenario, this means that the neurosurgeon-credit STILL can’t control the LLC (providing there is at least ONE other member) and in addition to waiting for distributions, as someone who actually OWNS a membership interest, he would then be responsible for paying taxes on the LLC’s profits. Not a particularly attractive position.
So the bottom line is, if your business has some valuable assets (this can include client lists, intellectual property or real property) it might be worth your while to look into whether it makes sense to have those assets owned and operated by a LLC (with at least two members) to provide a reasonably good level of asset protection. Furthermore, and very importantly, if you already operate a LLC that owns valuable assets, then you may want to make sure that the Operating Agreement is structured to maximize your protection from creditors that might come after its members.
Remember, this blog post is not tailored to your situation, is not legal advice, and should not be relied upon to make any important decisions. I recommend that you consult with a knowledgeable business law attorney if you are interested in how the information in this blog post might apply to your situation. Of course I would always welcome and appreciate the opportunity to help you if you choose.
Here’s to your legal success!