There are two kinds of legal risk for those who own a business or are self employed professionals. 

The first (and the most likely) is the legal liability that arises from the conduct of a trade or business. Thus, any business could be sued because of some claim by a customer or employee of the business. The same can happen with respect to the tenants of any rental properties. When you own a business, regardless of the legal form, a plaintiff will usually sue you as the owner, president, officer and/or director in addition to suing the business itself. Thus, the liability claim will usually be aimed at the owner as well as at the business. If the plaintiff prevails, the owner's personal assets will also be at risk if the business assets and insurance are not enough to settle the claim. 

Even if there is enough insurance to settle a claim from the first lawsuit, it will then become very difficult to get insurance or to find insurance that doesn't cost more than the profits generated from the business. 

I've concluded that it isn't practical or reasonable to protect all of the business assets from claims that arise within the business. The practical solution is to segregate some business assets and to protect non business assets (or assets of other businesses) from exposure to claims from within a business. 

The second form of risk arises from claims coming from outside the business rather than from within the business. This is much less likely unless you have more than one type of business. If you have invested some of your money in rental property, that could become the source of a claim. 

For example, the owner of a retail business also owns an apartment building. Someone is injured by an automobile owned by an employee of the retail business. The employee doesn't have any money or insurance and the accident occurred while going to or from work. The plaintiff sues the retailer and may win a judgment far in excess of the insurance and the assets of the business. The judgment will usually give the plaintiff the right to take any other property of the owner - including his apartment building and any personal assets. 

In most cases, any jointly owned property can also be taken. Thus, if the building owner is a joint owner of savings accounts and securities with a parent, the parents' assets could be taken. If the owners' spouse is a joint owner of the building, the spouse's assets can be taken. If the spouse is a joint owner of property with his or her parents, those assets could be taken.
The same thing can happen in the opposite direction if a claim arises from the retail business. The judgment creditor can take the apartment building and any personal assets or any jointly held assets.

The problem arises when someone sues a business and is given an award that is far in excess of the assets and the insurance of the business. 

The reasonable claims of employees, customers or others who may have future judgment claims against the company and the owner of a company should be satisfied with the insurance and any assets of the business. If a future claim exceeds the amount of insurance available because a jury or judge were to be extremely generous to a plaintiff, the question arises as to whether you have an obligation to make all of your family assets available to all unknown future claimants. 

Legally, the answer is no. You don't. 

Morally, the answer is less clear to some people. Do you have a moral obligation to pay more taxes than the law requires? Do you ask your doctor or accountant for a financial statement and proof of insurance before you hire them? Do you have a moral obligation not to operate your business as a corporation? Do you have a moral obligation to not use the protection of the bankruptcy laws to protect some of your assets? I don't think so. 

If a judgment is so great that it exceeds the insurance coverage and net assets of a business, a lot of innocent people will suffer a severe loss in order to pay the judgment to the plaintiff. The employees will lose their job. Suppliers will lose a significant source of business. Some suppliers may go broke. Customers of the business will lose a source of supply for the products or services provided by the business. Trade creditors of the business are likely to suffer a loss because the business owner had to take bankruptcy and the creditors didn't have secured claims against the assets of the business. 

In most cases, the business owner's family will lose all of their personal savings. In some cases, assets held jointly with parents or children will be taken. Retirement savings will be taken if they are not protected by ERISA or state law. The family home will be lost if it isn't protected by state law. 

People in business are faced with the prospect of this "teeterin' rock" existence as long as they do business with the public and have any employees. It's a wonder that anyone would continue to be a business owner/entrepreneur with the near certainty that a single claim by an employee or customer could wipe out a lifetime of work for the owner and the employees. 

In fact, I'm convinced that the litigation explosion is making more and more people decide not to become business owners. Potential jobs are lost. Productivity growth is lost. In time, the economic miracle of the American small business will die.
You can either remain exposed to the unlimited claims of some future disgruntled employee or customer or you can take steps to separate some of your assets from your business.

So what? Is there anything you can really do about it? 

I think the answer is a resounding YES. Here are a variety of suggestions and ideas that can help you to protect your personal savings from being taken as a result of legal claims that exceed the insurance and assets in your business. 

Make sure that your insurance is adequate for reasonable and normal claims, but not so great as to attract a lawsuit. Don't ever assume that potential plaintiffs or their attorneys can't find out how much insurance you have. 

Ask your insurance agent to help you make a risk management review of your business at least every three years or whenever there is any significant change in the business. A thorough risk management review will include an effort to identify all types of risk exposure that can occur anywhere within the business. One very enlightening way to do that is to have "brainstorming sessions" with your employees to get their ideas about anything in the business that could be a source of losing a significant amount of assets. If your business has too many employees to make this practical, limit the sessions to supervisors or managers. 

Take a good look at the various assets that your business owns in terms of potential legal claims. Are these assets still needed? Idle land and semi-idle equipment are examples. What part of your business is most susceptible to claims? Can it be spun off and isolated (legally) from the rest of your business? There may be no tax benefits from operating a business as multiple corporations, but there may be substantial legal benefits from splitting a business into separate parts with separate owners. 

The owners, operators or transporters of any hazardous waste are jointly and severally liable (without limit) for any waste cleanup costs. Past exposure can't be avoided, but you should exercise great care about taking title to any land in the future. Get an environmental waste inspection first. When you do buy land, consider using a separate legal entity (like a corporation) to own the land, thereby segregating the land from your other business assets. 

If you still do business as a proprietor or partner, you should carefully consider changing to some form of corporation or to a limited liability company. However, this may be of limited value if you provide any form of professional services, like a doctor, lawyer, engineer, accountant, etc. 

If you do operate a business as a corporation, you should avoid having your spouse or other family members as directors or officers of the business unless they actively work in the business in a management capacity. And, be sure to operate your corporation as a separate legal entity or the courts can "pierce the corporate veil" and ignore the existence of the corporation.
 

If possible, avoid being an employer. If not, consider having the business segregated so that all of the net worth is not in the same part of the business with the employees. Use leased employees if you only need part time or temporary help.

Don't give an unrestricted power of attorney to anyone other than a trusted and close relative, like a spouse, parent or an adult child. Consider using a "springing power" that isn't effective without some evidence that you are unable to manage your own affairs. If your family relationships aren't solid enough, discuss the problem with an attorney. A power of attorney can be drafted so that it is very limited or very broad. 

Eliminate the risk of having assets of other family members (like parents) that are exposed because of potential claims that might be filed against you and your jointly owned property. Use a power of attorney to give you the legal power to act on behalf of your parents but not to take their assets for your own use. 

Segregate most of the property owned jointly with your spouse, except for real estate owned in tenancy by the entirety. Consider using a power of attorney for each other to avoid unnecessary joint ownership. Eliminate the use of jointly held property with your children. Put it into a form that doesn't expose the property to your future creditors. 

Avoid giving or loaning property (or money) to anyone who might not be as careful about the use of the property as you are. Take greater care to avoid providing property to anyone who might be abusing alcohol or drugs or who may have poor judgment - like some teenagers. (If you have a teenager who is of driving age, it might be a good time to set up an offshore trust.) Similar problems can occur with older parents who have poor reflexes or have decreased mental capacity and quickness. 

If your business is one that is dependent on your active involvement, consider making gifts of the stock to your children, grandchildren, parents, spouse and others. Keep your own ownership interest below 50%. That way, if anyone should win a lawsuit against you and get your corporate stock, they won't be able to force a change in the operation of the business, even though they could become a major irritant to the business. If you have employees who are critical to the success of the business, consider giving (or selling) some stock to them. CAUTION: Be sure that you do not make yourself legally insolvent by making gifts of stock in your business to family members. 

Don't agree to serve on the board of any small business if you can avoid it. If not, insist on substantial officers and directors insurance and take steps to insulate your personal assets from claims arising from service on the board. 

Don't agree to serve as a trustee or executor unless you are willing to accept the substantial liability that comes with it. Be sure that you can hire competent professional help. Make sure that you have adequate insurance before you begin any duties. Don't agree to waive a bond or insurance. 

Make an effort to withdraw money from your business unless it's being actively used in the business. When the business needs some assets on a short term basis, provide it to the business in the form of a loan rather than as equity. (I realize there are some tax concerns that might limit this strategy.) 

If you want to keep money in a taxable corporation to avoid double taxation, one way to reduce the risk of having it taken by a judgment creditor of the business is to put it into a limited partnershipwith other limited partners. 

Segregate special purpose assets like college savings for your children. Pull that money out of the business and put it into an irrevocable trust or limited partnership. For minors, you could simply transfer the money to them under the Uniform Gift to Minors Act, but the children would then have full access to the money when they reach age 18 (in most states.). 

Avoid loan guarantees when possible. If your business needs to borrow money, you will most likely be asked to personally guarantee the loan. When you do so, remember that you are now exposing some or all of your personal assets to any claims arising from the lender. Try to avoid borrowing money that isn't clearly secured by specific assets of the business. Make an effort to find a lender who will accept collateral of specific assets in lieu of a loan guarantee. 

Provide equipment to your business by means of an equipment lease with a family owned limited liability company or limited partnership. Do the same thing with any real property that is used by the business. 

Put your low risk personal assets like cash, securities, gems, and collectibles into a family limited partnership that is owned by a variety of family members. The more partners there are who have an interest in the partnership, the less susceptible it will be to a challenge by a future creditor. Consider using a limited liability company to serve as the general partner. However, don't put personal use assets like appliances, cars or RVs into the partnership because you may be required to pay the partnership a "fair rental" for the use of the property. 

If your state of residence does not have a strong homestead exemption or tenancy by the entirety, give serious thought to using a home equity loan to encumber your home and then put the cash into a family limited partnership. 

Discuss the rules in your state with regard to qualified retirement plan assets and creditor's claims with a bankruptcy lawyer. If the assets are in a form that is protected by the Employee Retirement Security Act (ERISA), then those assets are protected until you begin to draw them out. Based on your review, avoid using the type of savings plan (such as an IRA or SEPP) that is subject to attachment in your state. 

Talk to your legal and insurance advisors about the benefits of having your life insurance owned by your heirs or by a trust for their benefit. Also review the laws in your state with regard to creditor protection for the cash value of life insurance or annuity policies that are owned by you.
If you are exposed to a high degree of legal risk and have at least $250,000 of liquid assets, then your personal assets (or your limited partnership units) could be put into an offshore trust for added protection.

No attempt was made to review the details of the various strategies. Those details include the income tax implications, the estate planning implications and business considerations. The most effective arrangement will result from a co-ordinated plan that takes into account all of the inter-related elements of income taxes, estate taxes and business factors. 

A critical part of the process of asset protection is to be sure that you are legally solvent with respect to present and prospective creditors before making gifts of any property that would make the property unavailable to your creditors. This type of analysis requires all of the information required for an estate plan, plus some additional details. Once you have gathered all of that information, you have most of the data that you need to evaluate various income and estate tax planning alternatives.
 

To avoid repetitive data gathering and analysis for different purposes, it makes a lot more sense to do it all at once. If you can't find a single advisor who is well versed in all of the relevant specialties, you will need to have your different advisors work together as a team.

Yours for greater financial security,
Vernon K. Jacobs

Further details about protecting your assets from future lawsuits  are available in our subscriber's web site. Changes in the tax laws and various federal and state laws affecting various asset protection devices are provided in our monthly newsletter on Asset Protection Strategies.

NOTICE: This Information is intended only for educational purposes and may be regarded as controversial by some legal experts. Readers should consult with a qualified  professional who is familiar with their specific financial and tax circumstances before adopting any ideas that are discussed in this article.

About the author:

Vernon Jacobs is a CPA/CLU who works as a tax author and consultant.  He  sponsors and moderates a free discussion group on asset protection and offshore topics.  His email address is vkj@rpifs.com.  He can be reached by phone or fax at (913) 362-9667.

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