All business professionals should be concerned about protecting their earned assets from the claims of creditors. Most businesses go through periods when sales are down or which are just starting out with too much debt or business expenses. Lawsuits and claims against businesses for injuries or unpaid obligations are not uncommon. If you are a sole proprietorship, any claim or lawsuit against you is really a claim on your personal assets.
You can protect your assets by creating the proper legal entity through which to conduct your business, such as a partnership, LLC or corporation. Other strategies include having adequate insurance and having a retirement plan.
Create a Legal Entity
An LLC or corporation can protect your personal assets from creditor claims so long as they are properly conducted. A limited partnership can offer protection for the limited partners though the general partner is still exposed to liability for any acts of the partnership. Some businesses create a number of separate corporations that own separate business assets, with one owning the real property, another owning the business equipment and one crafted for operating the business. All can lease the assets to the corporation operating the business so that any claim against one will not affect the others. When signing agreements or contracts for the corporation, however, be sure that you do not personally guarantee payment or else the protection the corporation provides will be irrelevant. Also, carefully adhere to the laws and rules regarding how your corporation’s business is conducted and do not commingle personal with corporate funds.
It is essential that you have adequate insurance to protect your assets from creditor and injury claims. Have a life insurance policy for your surviving family members since its proceeds cannot be seized by creditors. If you have commercial real estate, obtain fire, casualty and liability insurance that will cover the value of your property and protect you against slip and fall, product liability or malpractice claims. Inexpensive personal liability umbrella insurance can provide you additional insurance in case your limits on your standard policies are inadequate. You can also consider business interruption insurance if certain conditions are present that are preventing you from operating your business for a limited time. Talk to your insurance broker about the various insurance policies available to help protect your business and personal assets.
Funds that go into a retirement plan like an ERISA, which include pension and profit-sharing plans, have special protections. Creditors cannot reach your retirement funds while they are in your plan. In some states, creditors can claim them once they are distributed but other states have laws that continue to protect them even after distribution. Federal bankruptcy laws protect all funds in an IRA that is a rollover from a qualified ERISA or up to $1,000,000 if it is not.
Federal and state laws provide certain property exemptions. As indicated above, federal law exempts ERISA funds. Most states will protect equity in a homestead or primary residence with some offering an unlimited exemption while others limit the amount. If you have limited equity protection, you could create an LLC and borrow against the property with a home equity line of credit and place the proceeds into the LLC as an investment. Any other real property, such as a vacation home or condo, are not exempt and may be subject to creditor claims.
Fraudulent Transfer of Assets
Be aware, however, that your asset protection plans cannot be perceived as an attempt to defeat the rights and claims of creditors, even though this may have been your intended purpose, or any transfers may be voided as these are considered fraudulent transfers. A court will look at the following to see if a fraudulent transfer has occurred:
- If made with the intent to defraud or hinder a creditor
- If made without receiving the equivalent value in exchange for the transfer and the debtor intended or was expected to incur debts beyond his ability to pay or was about to engage in a transaction in which the remaining assets of the debtor were unreasonably small
The court will look to see to whom transfer was made such as a family member or good friend but the control of the funds or property remained substantially with the debtor. Other factors include whether you were sued or about to be sued before the transfer was made, if you attempted to conceal the assets, if you became insolvent after the transfer or the transfer amounted to all or nearly all of your assets.
Asset protection plans are necessary but consult with a financial expert or business attorney to discuss which strategies are best for your type of business and what you can legally do to protect your hard earned assets from the claims of creditors.