Asset Protection

What Is Asset Protection All About?

Although it is well known that a corporation or LLC is useful for asset protection, the mechanics of it are often obscure to the businessman. We have attempted to set forth below some of the principles regarding the issue.

There are two approaches to asset protection and they are often confused in discussion.

Protection of Personal Assets by Forming a Nevada, Wyoming, Delaware, or South Dakota Corporation for your Business

This approach provides for the formation of a corporation or LLC to operate a company so that if the business fails or a judgment is obtained by a dissatisfied or injured customer, the business entity will bear the brunt of the judgment and the personal assets of the client will not be available to the judgment creditor.

It is here that the concept of “piercing the corporate veil” arises. This is a principle that some courts have developed to enable a judgment creditor to “pierce” the corporation’s “veil” of protection and obtain a personal judgment against the owners of the business entity. To achieve this result the creditor must usually establish that the corporation or LLC is undercapitalized; the entity has not been run according to the legal requirements (e.g. not keeping minutes of meetings of the entity’s officers, directors and shareholders); using corporate funds to pay personal bills of the owners, etc.; or that to allow corporate protection would constitute a fraud upon the creditor.

The above listed states’ courts are very reluctant to pierce the corporate veils of corporations and LLCs and will usually do so only where the owners have perpetrated a fraud upon the Plaintiff. When the client has constructed an LLC, the statutes of these states spell out certain procedures for suing the LLC and prohibit even the naming of the members (owners) in a lawsuit against the LLC.  Further, these statutes spell out specifically that no member or manager is liable for the debts of the LLC.

Thus, the protection of the personal assets of the owner of a corporation or LLC against a creditor of the business is extremely strong in these states.

Protection of Personal Assets by Placing them in a Corporation

In this model, the client may have personal liability problems and wishes to protect his personal assets by placing them in another form such as under the umbrella of a Nevada, Wyoming, Delaware, or a South Dakota corporation or an LLC.

It must be noted at the outset that most states have statutes that allow a creditor to avoid any transfer of assets by a debtor that is made to avoid paying the creditor. If the client is to avail himself of the protection of a corporation and avoid the consequences of this type of statute he should create the entity and transfer the assets prior to the time when he can be accused of the transfer to avoid payment to the creditor and, certainly, before a judgment has been rendered against him. There is a legitimate argument that a transfer to an LLC is a transfer for value and not subject to the fraudulent conveyance acts. It would seem best to avoid having to use this argument if possible.

The issue, therefore, is not whether a court will allow a plaintiff to “pierce the corporate veil” of a corporation to obtain liability against an owner, but whether a court will allow a creditor to obtain assets of the corporation wherein the owner of the company is the debtor.

Where corporations are concerned, if the creditor discovers that the debtor is the owner of shares of stock of the entity, he can certainly obtain the shares just as he could obtain any other asset of the debtor to satisfy a judgment. Ownership of the shares, if sufficient in number, would allow the creditor to take over the business or to liquidate the business to satisfy the judgment.

The result is somewhat different where the ownership of the entity by the debtor is not shares of stock in a corporation, but, rather, membership (translate ownership) in an LLC. In this case, Nevada, Wyoming, Delaware, and South Dakota have statutes that provide that a creditor’s exclusive remedy, is to obtain a charging order against the LLC. This simply means that if any assets are to be distributed to the debtor, they may be taken by the creditor. The catch for the creditor is that he may not force any distribution of the assets to himself, and, being the equitable owner of the interest of the debtor, could be subjected to Federal income taxes on the proportionate share of the profits attributable to the debtor that he has been assigned in the charging order. The taxation issue has not been seriously litigated and may not prove to be the case.

It is a greater protection to the debtor that someone else own at least a small part of the membership of the LLC to thwart any attitude by a court that “since the organization” is owned entirely by the debtor, there is no harm in allowing the creditor to have the assets.”  Thus, it is highly unlikely that an attorney will seek a charging order for a creditor client where the only result would be that the creditor will not be able to obtain the funds, but could be liable for the income taxes on the profits.  We are experts in the formation of corporations in Wyoming, Nevada, Delaware, and South Dakota. Please call our counselors if we can be of assistance in answering your questions or in the formation of a business entity for your needs.