Courts have slowly eroded Asset Protection and Single Member LLC’s by allowing creditors to reach past the LLC to the owner or owners. An LLC, by itself is probably not enough protection for the average business owner.
Asset Protection and Single Member LLC’s are very rarely synonymous in the real world despite what one hears from marketers in theory. LLC’s are great for many things, but most business owners that think that paying a few hundred dollars to designate their business as an LLC, corporation, or LLP will adequately separate business assets from personal ones. They could be gravely mistaken. In fact, unless one follows the LLC rules to the letter, chances are that personal assets are on the table in the event of a lawsuit or bankruptcy; with a single-member LLC or even sometimes with a multi-member LLC. How many LLC owners log meeting minutes for every major business decision or never pay for personal items with the company checkbook? Either one of these can form a crack in the wall in which a good attorney can drive a wedge and allow the courts access to personal assets.
What can crack the walls of an LLC? Well, lets start out with the obvious. If a person were to set up an LLC for criminal, wrongful or fraudulent purposes, that person could be held liable for debts of the LLC. A little less obvious and more confusing is that courts have also looked passed LLC’s to personal assets by calling them “alter egos.” Basically, the court is saying that the LLC is just a business in name but actually just the owner in disguise. If the LLC is actually the owner, collecting debt from the LLC is also collecting debt from the person’s college fund for their children. Here’s one that perplexes. If the LLC is not adequately funded, then the court can go after personal assets. Most business owners start out with almost nothing and grow their business. Are the courts saying that someone is not protected while their business is growing? Maybe the courts are urging business owners not to protect their businesses with an LLC until they are larger? Either way, the current state doesn’t encourage startups or risk taking and the LLC doesn’t seem to be the answer, at least on its own.
If a business doesn’t hold up to a court’s scrutiny, the owner and the owner’s family could lose everything. In fact, here are some examples of just that:
In this case, young girl drowned in a public swimming pool owned by an LLC. The father of the deceased sued the LLC and asked the court to set aside the LLC for a judgment against the single-member of the LLC. The Supreme Court of California found a way around the LLC by determining that the LLC did not have enough assets to conduct a public swimming pool. The owner of the LLC, became personally responsible for the award in the lawsuit. Sometimes a horrible event happens like this and often courts will try to right the wrong, even when it takes a little bending of the law.
Another single-member LLC falls. Even after the LLC was essentially dissolved, the court could still go after the owner. In this case, Tradewinds group, a single-member LLC, contracted to have Martin construct an airplane hanger. Tradewinds eventually sued Martin for breach of contract and won. Martin appealed and the case was sent back to the court where the decision was reversed and Martin was awarded substantial litigation costs. Tradewinds had sold its assets to Freeman, the owner of Tradewinds. Martin went to court to disregard the LLC to collect from Freeman personally. The court found that Freeman was an “alter ego” of Tradewinds so they were one in the same. Freeman was held personally accountable for the judgment.
Even a multi-member LLC that fails could hide threats to one’s personal assets. Do you think personal assets are safe after an LLC files bankruptcy? This case involves a multi-member, closely held, LLC that declared Chapter 7 Bankruptcy. The trustee of the bankruptcy estate attempted to hold the members of the LLC personally responsible for debts. The court found that the members were personally responsible for several debts as they had “dealt with creditors personally” (How else would one do it?) and did not explicitly identify themselves as an agent of the LLC.
In this case, a single-member LLC entered into an agreement with the purchasers of a home to finish the home in certain amount of time. The LLC failed to do so. The purchasers successfully sued the LLC. The purchasers then targeted their sights on the assets of the owners. The court ruled that the LLC was intermingled with other entities and personal assets and is therefore to be disregarded and the owners were personally liable for any court awards. This illustrates that when the owner of an LLC neglects to follow the strict separation rules between personal and business assets, they can also endanger their personal assets.
In this case, an amateur softball association sued a single-member LLC over trademark infringement also naming the owner in the suit. The court ruled that the owner was personally liable because trademark infringement was simply enough to warrant it as a fraudulent act! This illustrates that sometimes courts will even make rulings that are so broad that one wonders why bother with an LLC at all.
In this case, a power company sued a single-member LLC. The power company attempted to collect from the owners of the LLC under a by piercing the veil of the LLC. The court found that since there was not enough funding, spaces were used for personal and business uses, they did not file annual reports, they did not file property records, or file tax returns, that the owners were liable for the award from the court. This illustrates that when an LLC is determined by the court to be “underfunded,” the court may find that that the LLC was just a front for the owner.
All of these cases illustrate a single powerful point. When something bad happens, an LLC by itself may not protect personal assets. A good lawyer will pour over all of the LLC documentation and generally will find something to start that crack in the wall. Even if they don’t succeed, they can use that crack to scare an owner or owners into a larger settlement. An LLC or LLP is a good thing, but, one wrapped in an UltraTrust can stop that crack before it even starts.
Steps to bankruptcy filing. Defines Chapter 7 and Chapter 13 filings. What are secured debts and unsecured debts? Discuss how to itemize assets to pay down debts and legal options for paying debt after filing for bankruptcy.
Asset Protection Myths: Asset Protection and Land Trusts
Last wills and testament with a revocable living trust
Prior to filing for bankruptcy you should consult with a lawyer regarding changing laws. The newest bankruptcy laws went into effect during 2005 and have made the filing process more difficult and expensive. A new provision to the bankruptcy law stipulates that a person must meet with a credit counselor and attend money management courses before their debt is discharged.
If you are contemplating filing for bankruptcy you should be aware there are two types of bankruptcy, Chapter 7 and Chapter 13, and each has its advantages and disadvantages. You should also familiarize yourself with the difference between secured and unsecured debt, as this will help you to protect your most valuable assets during bankruptcy.
What is Chapter 7 Bankruptcy?
Chapter 7 bankruptcy is intended to give people a fresh start. Assets are liquidated and used to pay creditors, although if you do not have assets of real value there is a chance to have your debt removed without giving much to the credit card companies. The new law makes filing for Chapter 7 more difficult because if your income is above your state’s median, and a judge determines you are financially able to pay at least twenty-five percent of the unsecured debt you will not be allowed to file.
What is Chapter 13 Bankruptcy?
You can make an appeal to the court that you have special circumstances, such as a natural disaster or severe illness, which further prevents you repaying the debt but most lawyers at this point will advise you to consider Chapter 13 bankruptcy. Chapter 13 bankruptcy puts you on a repayment plan with the creditors for a period of at least five years. The interest rates are often much lower than the original debt, and you are not responsible for debt unless it is specifically stated in your repayment plan. Under the new law courts will apply pre-set standards determined by the IRS to compute how much money you should allocate towards housing and food, and how much money you should have left to pay off your debt.
What is Secured Debt?
Once you and your lawyer have determined how you will file for bankruptcy, you should begin itemizing your assets and labeling your debt as secured and unsecured. Secured debt is credit given to you based on the value of the property you bought, such as a car loan. Should you fail to make payments the creditor with a secured interest in the property may have the item seized, and if the item is now worth less than your debt the creditor may sue you to make up the difference.
What is Unsecured Debt?
Unsecured debt is credit given to you solely on your promise to repay at a later date. An excellent example of unsecured debt is a credit card. Failure to pay unsecured debt may cause the creditor to obtain a judgment against you, and once this happens there is no hope of protecting your assets until your debt has been settled.
A creditor may obtain a judgment against you if your debt has remained unpaid for a long period of time, the balance of the debt is very high, or a combination of both. Once a judgment is obtained you are forced, by law, to pay back the debt you owe. To achieve this goal the creditor may request TO garnish your wages or even put a lien on your house to satisfy the debt.
How to Itemize Your Assets to Pay Down Debt
When itemizing your assets you should consider the value of your property in terms of what you could sell it for. Some debts such as your mortgage and taxes will not be absolved after you file bankruptcy, and you may consider selling some of your assets to pay down on these debts. Once you have taken stock of your assets, you can determine which of these assets are considered exempt property and untouchable by creditors.
Some states have very liberal homestead exemptions which allow you to keep a certain amount of your equity which will allow you to rebuild after declaring bankruptcy. States such as Florida and Texas allow you to keep all the equity in your home, whereas states like Alabama only allow you to retain the first $5,000. In states with more liberal homestead exemptions it may be to your benefit to use liquid assets to pay down on your equity. You can also refinance the equity from your homestead exemption and use the money to pay down on your unsecured debt.
Other Legal Options to Protect Your Assets During Bankruptcy
Other legal options for protecting your assets during bankruptcy are making annual contributions to your IRA or other pension plan. It is important to consult with an attorney to make sure your pension plan complies with federal standards for bankruptcy exemption before you move any funds from existing accounts. You may also tie up money by purchasing additional life insurance, obtaining an offshore annuity, or by gifting certain assets.
If you choose to transfer ownership of your assets, make sure this transfer is permanent since you are taking an oath when you file bankruptcy that you have accurately presented all of your assets for consideration in repaying debt. Your actions within the last ninety days before you file for bankruptcy will be highly scrutinized in court, and any suspicious activity may result in a denial of your case.
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Asset Protection Bankruptcy: Bankruptcy Code & Life Insurance
Asset Protection when facing bankruptcy can be viewed as a difficult task. There are some things that can be done to protect assets if there is no asset protection plan already in place. While this method discussed below will not solve all problems, it is a way for clients to protect some assets and leave insurance benefits to the family instead of sending money to the pockets of creditors.
Asset Protection and Bankruptcy: Bankruptcy Code and Life Insurance Can Provide Asset Protection
Asset protection is a major concern, especially among those who have considerable wealth. In addition to traditional asset protection planning methods such as an irrevocable trust, it is also possible to use the Bankruptcy Code in combination with life insurance to create an asset that is protected.
Most people know of another individual that has had to file for bankruptcy. The following information can be beneficial if you or someone you know is facing bankruptcy and has not done any irrevocable trust asset protection. It is possible to protect and retain many assets from the bankruptcy creditors.
Asset Protection Going into Bankruptcy
When an individual is going into bankruptcy, they usually have the mindset that all liquid wealth they have will be lost in the bankruptcy and will then be divided among various creditors. Without the right asset protection planning, this is often what happens. However, the bankruptcy laws will allow an individual to retain $10,775 of any life insurance contract that has not matured. The policy must be owned by the debtor and the debtor or their dependents must be insured by the policy. This is under bankruptcy law §522(d)(8).
There are some unique opportunities for clients to protect their assets by using the bankruptcy law in combination with no-cash value policies.
An Example of Bankruptcy Asset Protection
For example Mr. Brown, age 51, who realizes his creditors will soon be closing in and will force him to file for bankruptcy. He has debts that are more significant than his assets; he has not created an irrevocable trust to hold his biggest assets, and will soon have no choice but to file for bankruptcy to clear him from the growing debt. We shall assume that he has $45,000 of liquid wealth in a bank or brokerage account. Under the current bankruptcy laws, Mr. Brown could take $25,000 and pay a premium payment into a no cash value UL policy that has a guaranteed death benefit. For this example, we will say the death benefit is $350,000.
The question now is what will be the cash surrender value of that policy in one year from now? It will definitely be less than $10,775. This means that $45,000 that would have been handed over to creditors will instead end up providing a guaranteed $350,000 life insurance policy that will become an asset to the family for their entire life.
This may not be the best solution when it comes to bankruptcy and asset protection issues, but it would be better to give the money to the family as a lifetime benefit instead of turning it over to the creditors.
Is Life Insurance for Asset Protection during Bankruptcy Fraudulent Conveyance?
One question many clients will ask is if this act is in violation of fraudulent conveyance laws. The answer is no. To begin with, it is not a conveyance at all, so it should not be deemed a fraudulent conveyance. The individual that is transferring the money from a certain bank account into a life insurance policy is not transferring any ownership. In addition, that same individual who had the money in the bank will also be the owner of the life insurance policy.
It may be confusing as to how this could be fair and it seems to contradict the rights of the creditor. Many creditors will see it in this manner, however, there are many cases in which the bankruptcy trustee has unsuccessfully argued that the use of life insurance as an asset protection tool for pre-bankruptcy will place creditors at a disadvantage by defeating the chances of the creditor getting the amount that is owed to them. Due to these arguments, the courts have been forced to weigh the debtor’s rights versus the rights of the creditors. So far, the advantage goes to the debtors.