Asset Protection with LLCs and Corporations

There are many lawyers and other who practice in the area of asset protection.  I generally believe that asset protection is a myth but that is because most clients and potential clients that come to me to talk about forming a corporation or LLC have an incomplete understanding about the protection that is available.  There are viable strategies to protect assets but LLCs and corporations have a limited ability to protect personal assets despite the common perception.

I have conversations regularly with clients where I hear something like, “I have a corporation so I thought my assets were completely protected!”  Most of the time, this is not true and clients are often shocked to find this out, usually after it is too late to do anything about it.

The term “LLC” stands for “Limited Liability Company”.  Why, if the even as the name suggests, the purpose is to limit liability, would assets not be protected?  The problem is not necessarily in the theory (i.e., by law, owners of an LLC or corporation are protected from liability) but in practice and because these entities are animals of state law and each state is different.

The basic rule is that the owners of a limited liability entity (a corporation or LLC) are not liable for the debts of the company.  The purpose of this rule to to encourage investment in business enterprises.  However, as you can imagine, people have been abusing this protection for almost as long as these entities have been in existence.  An example of an abuse would be to form a corporation, borrow money in the name of the corporate, take the money out and let the company default on the loan and move on and do it again.  These kinds of schemes have existed over time and the courts have responded with a legal idea called “piercing the corporate veil”, an odd term that essentially means that creditors can reach the assets of the company to pay debts under certain circumstances.

What are those circumstances?  There’s no clear rule on this because the courts, over time, have found various reasons to “pierce the veil.”  As a general rule, though, the veil can be pierced when the company is not really operated as a company such as when the owners commingle the company and personal money or if the company is undercapitalized.   A recent case in Wyoming set a standard for piercing the corporate veil in that state (note that I am not licensed in Wyoming and cannot comment on Wyoming law.)  The court said:

The veil of a limited liability company may be pierced under exceptional circumstances when: (1) the limited liability company is not only owned, influenced and governed by its members, but the required separateness has ceased to exist due to misuse of the limited liability company; and (2) the facts are such that an adherence to the fiction of its separate existence would, under the particular circumstances, lead to injustice, fundamental unfairness, or inequity.

The Court looked to the factors (which were not the only possible factors that other courts could consider): (1) presence of fraud, (2) inadequate capitalization, (3) the degree to which the business and finances of the LLC and its member are intermingled, and (4) manipulation of assets and liabilities between the LLC and its member to concentrate the assets in the member and the liabilities in the LLC. The Court repeated that the analysis is fact-driven (i.e., it is not always going to be the same from one case to another) and clarified that no one factor, except fraud, alone justifies piercing an LLC’s veil of limited liability. Additionally, to pierce the veil, “an injustice or unfairness must always be proven.”

If you have an LLC or a corporation and you want to make sure that your assets are protected, you might want to consider the following among other strategies:

(1) keep adequate funds in the LLC’s operating account, allowing it to pay all debts as they come due,

(2) consider using a separate accountant for the LLC’s bookkeeping,

(3) establish separate mailing addresses for the entities,

(4) acknowledge and prioritize ongoing LLC compliance responsibilities, and

(5) ensure that all liabilities associated with any tax benefits derived from an LLC are satisfied in full in a timely manner.

Of course, none of this matters if the owners have signed personal guarantees or if the company owes certain kinds of taxes which allow the government to pursue owners.

The bottom line is that there are many exceptions to, and many operational requirements to obtain, personal asset protections from a corporation.

Please be advised, this article is for informational purposes only and does not constitute legal advice or opinion. Always seek the advice of legal counsel prior to making legal decisions.