The ABCs and the XYZs of Asset Protection

Most business owners understand the basics of forming a legal entity. You create an LLC or corporation to separate your personal assets from business risk. That is legal structure on the ABC level. For many growing businesses; however, that first entity might only be the starting point. Over time, legal structures can fail not because they were created or managed incorrectly, but because they were too simple for the level of risk involved.

It's sort of like building fortifications according to the level of threats you are facing!

Why a Single Entity Is Not Always Enough

A basic LLC or corporation provides important protection. Still, plaintiff lawyers know how to challenge it. If there is a serious claim, they may try to “pierce the corporate veil” and reach personal assets.

For example, you might compare it to an earlier era fort. The original castles were little more than fortified manors or simple hill forts. In essence, if an enemy breached the only wall, there were no additional barriers. As risk of invasion increased, the castles grew in proportion by adding outer walls, battlements, archery towers, revetments, moats, etc. The fortifications were adjusted or developed proportionate to the threat.

These were good against unsophisticated foes but were insufficient for anything more than temporary shelter.

Risk to a business increases when:

1. A business owns multiple lines of work – each type of work carries risk that’s often particular to that line of work. A useful example would be a transportation line versus a crop production line. The transportation line involves threat of driver injuries, auto accidents, damage to cargo, fuel or equipment repair costs, etc. The crop production line would involve potential chemical spills, biological infestations, falling market conditions, weather, crop failures, etc. In essence, having both lines of business in the same company exposes the whole to failure across multiple axes. Separate them and then, if one fails, the other is unaffected.

Transportation of caustic chemicals should not be paired with any other line of business because of the risk.

2. Operations span different locations – Countries, states, municipalities, even different counties have specific regulatory differences, taxation schemes, cultural or societal risks, etc. Many states, for instance, carry heavier regulations for “foreign” entities while domestic entities are favored. It only makes sense to anchor your operations in a domestic entity rather than try to operate from another location where the laws might be significantly different.

3. Some activities carry more risk than others – obviously, a highly risky business could “contaminate” or threaten a more stable and predictable line of business. If you were manufacturing highly toxic chemicals, you would certainly want to isolate the threat of a liability lawsuit such as workers compensation, regulatory (OSHA type complaints), or a property or personal injury matter.

4. The owner has accumulated significant assets – “Deep Pockets” is a term meaning a person or entity has significant assets and therefore is a target of litigation. When the “treasure chest” grows, the takers flock to it. Don’t allow your company to be a big, slow “yummy” elephant…instead make it into a pride of fast-moving lions. In other words, greater wealth will require additional protection.

Your stack of cash will always be the target.

To follow our fortifications example, you shouldn’t lump all your business lines in multiple jurisdictions into one single entity, because that potentially becomes your single point of failure. (e.g., hill fort rather than multi-layered castle.)

How XYZs Complexity Adds Protection

In certain situations, adding structure can strengthen protection. One common approach is a holding company model. In this structure:

An individual owns a holding company; the holding company owns separate operating companies; each operating company handles a distinct business or location.

This setup does two important things: First, it creates a layer of legal separation between the owner and day-to-day operations, and thus a claim against one operating company must clear multiple legal hurdles before reaching personal assets; Second, it isolates risk between business units so if one operating company faces a major liability, the assets of the other companies are generally protected.

This approach can work well for:

- Real estate owners with multiple properties

- Businesses operating in multiple cities

- Owners with different industries under one umbrella

- Companies with varying risk profiles

Complexity Only Works If You USE It

Don't let a threat sneak up on you...be prepared!

Legal structure is not a magic shield. Complexity only helps if it is maintained properly, and that means you must have:

1.      Separate bank accounts for each entity – shared accounts combine the entities into a single target;

2.      Separate books and records – again shared records means you are combining the entities so why shouldn’t a court “combine” them too?

3.      Proper operating and shareholders’ agreements – to delineate ownership and governance like a “real” company;

4.      Regular meetings and documented decisions – this is referred to as maintaining the “formalities” just you would for a real company with real shareholders/interest holders; and finally, here’s the BIG KICKER,

5.      No commingling of funds – you can’t take your company credit card for shopping or vacations and expect a court to find that your company is anything more than your personal piggy bank.

When business owners cut corners, complexity can backfire. Poor administration or business practices give plaintiff lawyers exactly what they need to argue that the structure should be ignored. This is what is referred to as “piercing the corporate veil.”

In conclusion, this is where legal planning and business discipline must work together. After all, what is the point of building a complex, multi-layered castle and then leaving the gate open, firing all your guards and letting the moat slowly drain away? Take the next step toward protecting your businesses. If your operations have grown, diversified, or taken on more risk, your legal structure should evolve as well.

Curry Andrews, Attorney