On July 4, I was in my vegetable garden getting some summer squash and zucchini to make kabobs for the family party. I was down on my hands and knees so I could harvest some of the early growth. As I picked a summer squash, I saw something move. I realized I was face to face with a rattlesnake. I dropped the squash and came in the house to regroup. I am not as young and quick as I used to be and I knew I would need some help. I admit that a snake was the last thing I expected to see in my garden.
Just like the snake in my garden, we all have snakes lying in wait for us when and where we least expect it. Asset protection is more important today than it was 20 years ago. Today the attitude is “if you’ve got assets, you must be taking advantage of people and not paying your fair share, so we should take them away.” It doesn’t matter if you are low profile, careful, or not the type. At some point you will run into that unexpected snake. It might be a lawsuit, an illness, a government agency, such as the IRS, EPA, OSHA, etc. It might be your tenants, your neighbor, your employee or just some stranger on the street.
Wondering how to protect yourself? You need to create a legal shield to put your assets behind. You need to create that shield now before the snake shows itself. If all your property is protected and you don’t have any assets available, the snake will just slither away.
Lawyers can create a “legal shield” using corporations, LLCs, trusts, limited partnerships and other “legal tools.” I call them the “legal tools of wealth.” Each entity or tool needs to be put in place with the others to form a legal shield. Yet each tool needs to stand alone. The trick is to separate the legal tools, so that if one of the tools gets “sued,” your other assets are safe.
Some lawyers love to stack legal entity upon legal entity to make a big “fortress.” Think of the fees! I see schemes where the general partner of the limited partnership is a corporation, and then the corporation is held by a trust, which is the member of an overriding LLC.
The problem with this fortress is that it is so heavy it will collapse under its own weight. You can’t keep up the details and paperwork to make all the different legal tools work. When this fortress is attacked, all the opposing attorney has to do is find a slip-up in the details of one of the legal structures. If someone forgot to pay the yearly fees on one tool or the minutes aren’t up to date, the attacker is home free. The entire structure unravels because all the tools are all linked together. If one link breaks, you could lose everything.
I recommend using two or maybe three legal tools. The easiest to use and strongest asset protection legal tool you can use today is the Limited Liability Company. An LLC has double the asset protection of a corporation, and it can be taxed any way you wish. This is really a very flexible legal tool.
I mentioned that an LLC is easy to use and that is really important. To get the legal protection you want from the unexpected snakes, you must have the LLC set up properly and also maintained. You may have heard that an LLC doesn’t require the same “maintenance” a corporation does. This is somewhat true, and it yet isn’t completely. In many states, laws have been passed to make LLCs simple by saying that an LLC doesn’t have to follow corporate formalities. (See Utah’s LLC laws for an example.) However there is still a problem. There is more to the story.
I have seen lawsuits where the Plaintiff claims that the LLC is a sham. Their argument is that the LLC is only an “alter ego”. In order to prove that the company is real, the defendant will have to show the judge that the LLC was maintained like a real company. At that point all of the corporate formalities are brought forward. So the truth is that you need to follow the corporate formality rules.
Another weakness that lets the snakes past an LLC is the lack of an effective operating agreement. Your operating agreement is the heart of your LLC’s protection. It is the structure that determines whether your LLC will live or die. A good operating agreement should be about 20 – 30 pages long (see this post for more on why). If you are lacking something in your operating agreement, you can amend it.
The final word is that you never know when you will meet a rattlesnake. Prepare for that time by getting a legal structure in place. If you are relying on an LLC to protect you from snakes, make sure you have your operating agreement and formalities in place so it gives you maximum asset protection and tax advantages.
Lee R. Phillips, Counselor United States Supreme Court Counselor