An LLC offers two types of asset protection, but their effectiveness varies based on the state of organization, the number of members, and operational methods. These protective measures include the corporate veil and charging order protection.
This is because a company, whether LLC or Corporation, is considered to be its own legal entity with its own rights. It may sound odd, but this is how the law is written and the Supreme Court has continually upheld the tradition for hundreds of years. Varieties of this law exist worldwide.
How an LLC Protects Your Assets
When you form an LLC, you are creating a new business entity. This is formed completely separate from its owners, and it offers you limited liability protection. As a general rule, if an LLC can’t pay its debts, then the creditors cannot go after the owner's bank accounts or assets. Instead, LLC’s creditors can only go after the LLC’s bank account and other assets.
What does an LLC not protect you against?
When it comes to personal liability, an LLC will not protect against this. This means that due to your own negligence, malpractice, or other personal wrongdoing, that you commit related to your business, you cannot shield your assets This is why it is essential to hold liability insurance.
Corporate Veil - Limited Liability
The corporate veil refers to the protection of personal assets from business liabilities. If your company is sued, then the creditor can only pursue the company’s assets. They cannot pierce the corporate veil and pursue the owner’s assets. The exceptions to this rule vary by state so it’s important to understand not all the following apply to all states.
For example, Wyoming has no minimum capitalization requirement. Nor does maintaining corporate records justify piercing the veil. For this reason, Wyoming LLC asset protection is considered the strongest in the nation.
Depending on the state, the corporate veil can sometimes be pierced due to:
- - Fraud
- - Falsifying documents or lying to obtain a loan or contract are examples of fraud. This is generally only pursued if the other party experiences financial loss, but not necessarily.
- - Commingling of Funds
- - If a business operates using an individual’s bank account, or if personal expenses are run through a company’s account, then commingling has occurred. This makes it hard to determine what is and isn’t a company asset.
- - Undercapitalization
- - This is when there is insufficient starting capital to meet expected operating expenses and liabilities. It’s an indicator the business was not created as a genuine stand alone entity.
- - Failure to Follow Corporate Formalities
- - This includes signing organizational minutes, the operating agreement, and holding regular meetings, e.g. annual meetings and special meetings when major corporate events occur such as a name change.
- - Operating Two Companies as One
- - This argument is generally made against wholly owned subsidiaries. A judge can be tempted to pierce the child company’s veil and attack the parent company’s assets.
- - Alter Ego
- - This is when a person and the company are considered to be operating as one. Essentially, business funds and personal funds are shared, an operating agreement isn’t signed, etc. The Articles of Organization are filed, put in a drawer, and ignored.
Charging Order Protection - Outside In
This aspect is less commonly known and understood. If an owner is sued individually for actions engaged in during their personal life, e.g. a car wreck or accident at their home, can the creditor pursue their business assets? It depends on the state, unfortunately.
Let’s begin with why this is important. Imagine you’re in a business partnership and one of your partners is sued, loses and their ownership in the company is transferred to the creditor. The creditor can now vote. Depending upon their ownership percentage they can also force distributions. In either case, the creditor’s business desires are likely different from the original partner’s. Would this make you feel confident in your investment going forward?
Most states provide some form of charging order protection for multi-member limited liability companies to avoid precisely this scenario. Where it’s interesting is for single-member LLCs. Wyoming is the only state which says a charging order is the sole remedy for a creditor regardless of how many members there are. That means even if you are the only owner, a personal creditor cannot seize your membership interest and take your business assets.
Who Owns the Assets in an LLC
The assets inside an LLC are owned by the LLC. The company is in turn owned by its members. This means the members indirectly own the assets in an LLC, but must follow the operating agreement and relevant laws when using them. This protects partners and ensures the law is followed.
Assets with a title, e.g. real estate or a car, should have the LLC’s name on the title. You shouldn’t use business real estate for personal purposes. If you must use it, then you can pay fair market value. This prevents commingling and upsetting partners.
Assets without a title, e.g. food, clothes, computers, can be purchased using company funds. It’s then easy to show a company card or check paid for the asset and it’s thus owned by the company. In some cases, especially when starting a company, you may need to put personal assets into the company. You are allowed to put personal assets in. Just ensure you document the transfer by using a contribution form.
Regardless of how the assets came into the company, once inside the LLC they are owned by the LLC. They can be distributed by following the operating agreement or when the company is dissolved, but the operating agreement and law must be followed.
Single-Member LLC
A single-member company can be seen as a funny thing because there is only one owner, so surely the company and owner are the same? How does this affect asset protection? It depends on the state.
Charging order protection for single-member limited liability companies are only available in Wyoming and Nevada. We prefer Wyoming because the law is stronger and the fees are lower, but both are strong from an asset protection perspective.
The corporate veil’s application is checkered across states. California is notorious for disrespecting the corporate veil, even for multi-member LLCs! We like to say it’s a decent place to vacation, but not to do business. It’s best to maintain a separate bank account, hold regular meetings, and obey all corporate formalities to increase your chance of prevailing in case of a lawsuit.
While you may need to form your operating company in an unfriendly state, you can establish a holding company elsewhere. This provides a double veil and allows the best of both worlds wherein you obey local rules by having an entity there, but take advantage of stronger laws elsewhere for valuable assets. Learn how to protect assets using a holding company here.
Multi-Member LLC
Who Can be a Member
There are few limitations on who can own an LLC. They can be owned by individuals and even minors. In that case, the child’s parents must sign on their behalf as a minor cannot enter into a contract, and an operating agreement is a contract.
Beyond people, an LLC can be owned by another LLC, a corporation, or a trust. This versatility allows for advanced asset protection and estate planning.
Wyoming LLCs
We provide an honorable mention to Wyoming LLCs. Wyoming was the first state to allow the formation of LLCs and continues leading to this day with the most aggressive asset protection laws. Nevada LLCs are close, but the legislature has become less friendly while raising fees.
Improving Limited Liability Company Asset Protection
Strategies to Improve LLC Asset Protection
- Purchase Insurance: By having insurance you can also limit your liability when it comes to negligence or personal mistakes that you make in relation to your business. Although your LLC may not protect you from everything, having insurance will.
- Elect Corporate status: LLCs are able to elect the tax status it wishes to hold. This means that as an LLC you can elect corporate status.
- Independent Entity: In corporate law, shareholders that mix personal assets with corporate assets are held liable for anything that may occur. This can also occur with LLCs. To avoid this, keeping LLC finances completely separate and as a separate entity is necessary. Your LLC should have its own bank account and credit cards, as well as contracts, invoices, purchase orders, and other important documents that should have the name of the LLC on them.
- Establish credit: Having personal guarantees for a company is one way that you can become liable for company debts. If you guarantee something such as a lease, or even a loan, then you would be agreeing to pay these should the LLC not be able to. Essentially you will be a guarantor. In some cases you may even be asked to pledge your assets. Avoid this by obtaining credit for your business alone. You can do this by paying your bills on time and showing a track record of real revenue and profit.
- Use Trusts: If your LLC is sued, then any money that is in the LLC can be taken by the creditor. The purpose of the LLC is essentially to ensure that a creditor cannot access your personal assets. To minimize your risk, you should keep as little money in your company as possible, and pay the rest either to the owners, or a trust.
It is important to note a few limitations on this. If you owe a creditor and transfer money out of the company, then the transaction may be taken as fraudulent. If you do not keep enough money in the company in order to pay the expenses, the court may hold you personally liable regardless. This will eventually lead to undercapitalization of your business and even possibly a lawsuit seen as an effort to defraud business creditors.
Final Thoughts
Asset protection is of the utmost importance for anyone running a business, even for those who think they are in a non-risky industry or have few assets to lose. Understanding the limits of the protection and how to maximize its benefits are key to properly utilizing your company. After all, LLC stands for Limited Liability Company because it limits your personal and business liability.
As each jurisdiction makes its own rules, we encourage performing further research to determine the best state or country to organize your company. We personally recommend forming a Wyoming LLC given they have the most aggressive asset protection statutes. Please fill out our contact form if you have any questions for us about forming your LLC. Additionally, for those seeking further clarification, attorney consultations are readily available.
LLCs are a business structure where the owners are afforded separation from their business. Forming a limited liability company (LLC) offers you liability protection from the debts and liabilities of your business. This means that if your business is sued you will be given protection for your own personal assets. Rather than have creditors come for your home, bank accounts, or personal items, they would be untouchable. You would only be at risk for what you have put into the company. Limited liability companies offer this benefit that is given to corporations as well, but also offer some benefits from that of a partnership or sole proprietorship.
