Administrative Compliance – A Necessary Pain

If you don’t manage the administrative end of your business well, then your asset protection structures are potential liabilities. Judges can and often do pierce the corporate veil. There are specific actions you can take to fully leverage asset protection laws while minimizing your domestic risk exposure. All of these are things that need to be done BEFORE you go offshore. This article applies no matter where you live in the U.S., but for demonstation purposes, I’m going to focus on Texas Asset Protection Law.

Asset Protection – A Broad Area of Law

Asset protection law is not an area of law that’s confined to a finite set of legal principles. To fully leverage and take advantage of asset protection laws, good asset protection attorneys must be versed in corporate, estate, trust, and employment laws, to name a few. With respect to corporate law and the issue of choosing a business entity (e.g. LLC vs. FLP vs. Corporation), one major risk is that a court could “pierce the corporate veil. In other words, in same cases the courts allow creditors to “break” the protections provided by business entities and pursue individual partners, shareholders, or members to satisfy legal claims.

Inside vs. Outside Liabilities

To fully understand this concept, it’s important to first understand the difference between inside and outside liabilities. Inside liabilities are liabilities directly incurred by a business entity. The business entity itself is solely responsible for these claims, in theory at least. Outside liabilities are those incurred by individual members, partners, or shareholders outside of the guise of corporate action. Again, in theory the individuals who incurred the liabilities should be solely responsible for meeting the obligations.

Comply With Corporate Formalities for Maximum Asset Protection

Corporate asset protection law protects shareholders, partners, and members of business entities from creditor claims agains the business entity itself. In other words, inside liability creditors are (in theory) only permitted to seize, levy, and otherwise execute on the assets of the business entity itself to satisfy their claims. So keeping your business entity “slim on assets” is an easy way to take full advantage of domestic asset protection laws, right? Unfortunately, “undercapitalization” is one of many factors that court consider when deciding whether or not to pierce the corporate veil — when deciding whether it is lawfully appropriate to look to the assets of individual shareholders, members, or partners to satisfy corporate obligations.

Although veil piercing laws vary according to jurisdiction (e.g. Texas Asset Protection Laws differ from Florida or California Asset Protection), there are a few things you can do now to minimize the chance that a court will pierce the corporation in the event that your business is sued:

  1. Make sure that the formation documents for your business entity have been filed with the Secretary of State in your jurisdiction, and make sure that you have the appropriate organizational and operational governing documents. If your business is formed in a state other than the state where it primarily operates, check with an attorney as to whether your business needs to be qualified in the states where it has a presence.
  2. Conduct all required meetings. Depending on your state and the type of asset protection entity you have, you might be required to have records of an initial organizational meeting and/or other required meetings (e.g. annual board of directors meeting). In Texas, a corporation is required to have $1,000 in capital before it can begin operating or incur debt. Does your state have a similar requirement?
  3. Document business transactions and keep records of internal business meetings. Always use the name of your business entity (and not your personal name) when transacting business and in advertisements. Unless you are a professional (doctor, dentist, chiropractor, lawyer, etc.), your business needs to operate under its own name. No exceptions.
  4. Maintain a separate checking account for your business, and make sure that business assets are titled in the name of the business itself. Treat your business as if it is a separate person — as if it is a person with a jealous desire to maintain its own autonomy. Never operate your business or allow it to own assets in any capacity as your own alter-ego.

In addition to maximizing the effectiveness of asset protection planing, business owners with high potential liabilities (e.g. surgeons) should conduct a reasoned cost-benefit analysis on the question of professional and/or business liability insurance. Such insurance should include general liability, professional liability (errors & omissions or malpractice), officer and director, workers compensation, and property damage.

If you have been a business owner for any amount of time, you have probably heard all the advice in this article before, but it is important an important subject — important enough to be revisited from time to time. It’s also worth the effort to set up some simple methods of “automatic compliance” so that nothing slips through the cracks. It’s the only way to take full advantage of asset protection laws.