How to Avoid Sabotaging your Limited Liability Company or S-Corporation – Part I
Limited Liability Companies have become the preferred way to own and operate a small business or to own rental or commercial real estate. Sub-Chapter S Corporations are also still common. There are sound reasons why LLC’s and Sub-S Corps are so popular. One is to protect personal assets from liability for claims arising out of operating a business or rental or commercial real estate. Another is to protect business assets from personal lawsuits against the business owner.
These business entities can be very effective for these goals. But many people unknowingly undermine their LLC’s and S Corps and the results can be very costly.
This article will discuss the seven most critical errors that can jeopardize or doom the asset protection benefits of your LLC or S Corp. The first installment will cover the top 3 mistakes – not properly completing the creation of your entity, improper asset ownership, and not operating your company properly to respect its separateness.
In Part II, we will cover failure to isolate sources of liability, choosing the wrong legal entity, forgetting the number one asset protection tool, and failing to understand what asset protection is really all about.
1. Not Finishing the Job You Started
We often see people who own small businesses, residential real estate, commercial real estate, and equipment or vehicles used in business. They own these assets in LLC’s or S Corps in case of a claim or lawsuit. But when we examine their paperwork, we learn that the reality of their situation is sometimes different than what they think.
Setting up an LLC begins with filing a form with the Secretary of State. In Ohio, this filing is called the Articles of Organization. Ohio has made this step very easy by recently enabling the filing to be done online.
Unfortunately, many people start and stop the process with this filing in the mistaken belief that it is all that is needed to create an LLC and get lawsuit protection. This is not surprising in this do-it-yourself world where anyone with a computer or mobile device and a web browser thinks they can handle any legal or business task on their own.
To have a fully effective LLC that provides asset protection, the owner must also create and sign an Operating Agreement that defines all aspects of operations and governance of the entity. Assets must be changed to company ownership, member certificates or other proof of ownership should be created, bank accounts should be set up, a Taxpayer Identification Number should secured in some cases from the IRS, a tax election should be filed, and usually a number of other steps peculiar to the business or industry should be taken.
Setting up an S Corp is a similar but more complex process. It starts with subscriptions for shares of stock and filing Articles of Incorporation with the Secretary of State, followed by a Shareholders Meeting, election of a Board of Directors, appointment of officers, and multiple other steps.
If these formalities are not completed, the company is not fully formed — whether it be an S Corp or LLC. This could be a fatal error in the future if there is a claim or lawsuit.
If your company is sued and the creditor attempts to collect on his court judgment against the company by seizing your personal assets, you may think that the claim stops at the LLC or S Corp. But if you have not completed the formalities of setting up your entity fully and correctly, courts will not allow you to shelter your assets and hide behind the veil of the LLC or S Corp. If you have not respected the business entity set up rules, then you cannot expect a court to respect the entity either. Your personal assets will not be protected.
The solution is to promptly complete all steps in setting up your company, and consult a qualified lawyer to be sure that you have not left any details unattended. What you do not know can hurt you later. There is no website or document creation service that can substitute for the wisdom, skills and experience of a lawyer.
2. Improper Ownership of Assets
This mistake is not as common as mistake number one but it can be fatal. To get LLC or S Corp protection from lawsuits, the business assets must be owned by the company.
For real estate, the title of the property must be changed to the company through a new deed. If there are renters, the lease agreements must be assigned to the company. Ownership of hard assets such as equipment, machinery, and vehicles must be changed to the company. The property and casualty insurance coverage must also be changed.
If you operate your company while the supposed business assets are still in your personal name, it will be a difficult sales job to convince a court that your personal assets should not be reachable by company creditors, or that a court judgment cannot be collected against your company’s assets.
3. Not Running Your Company Correctly
It is a cardinal rule that business expenses are paid from the business and personal expenses of the business owner are paid from the owner’s personal accounts if you want your LLC or S Corp to protect your personal wealth. If you use your company to pay your personal bills, you are inviting a plaintiff’s lawyer to “pierce the veil” that would be available via your S Corp or LLC. If you mix business and personal expenses in the company’s books, you will have a tough job to convince and court that you and your business are separate and not just alter egos of each other.
Another failure is to run the business like it is your personal alter ego. It is important to follow the provisions in the company’s governing instruments about company operations. For an LLC, that would usually be the Operating Agreement. For an S Corp, that would be the Code of Regulations, Articles of Incorporation, a Close Corporation Agreement, or other shareholder agreements. If you fail to respect and observe the legal formalities that you yourself have set up for your company, the courts will not assert those legal formalities against creditors with court judgments.
For help setting up a LLC or S Corp or if you would like us to review your setup give us a call at 513.721.1513 to speak with a member of our legal team about the compassionate and knowledgeable legal representation we can offer. Call now to get started.
This article is intended for educational purposes only, and is not meant to be a thorough and exhaustive discussion of all relevant planning and legal issues. Do not take action in sole reliance on this article. Consult a qualified lawyer in your state of residence.
Copyright © 2017. Zimmer Law Firm, LLC. All rights reserved.