The risk of liability is a very real concern for today’s business owners. There are employment-related issues including wrongful termination, sexual harassment, and discrimination; careless business partners and employees; and contractual obligations that may include personal guarantees, leases, business agreements, etc. There are also personal liabilities like divorce, vehicle accidents, and rental real estate.
Unfortunately, our litigious society necessitates that a broad range of people, including business owners, board members, real estate investors, private practitioners and retirees, should protect their hard-earned assets from a variety of liabilities. We have outlined some strategies for business owners and practitioners that may help provide protection from risk.
Key Take-aways to Protect Yourself from Risk:
● Types of liability insurance you need to have in place;
● State exemptions that will protect certain assets from the claims of creditors; and
● The role of business entities in liability planning.
Tip #1 – Insurance is the First Line of Defense Against Liability
Liability insurance is the first line of defense against any claim. Liability insurance provides a source of funds to pay legal fees as well as settlements or judgments.
The types of insurance you should consider include:
● Homeowner’s insurance
● Property and casualty insurance
● Excess liability insurance (also known as “umbrella” insurance)
● Automobile and other vehicle (motorcycle, boat, airplane) insurance
● General business insurance
● Professional liability insurance
● Director and officer insurance
Planning Tip: Never rely on insurance as your sole means of liability protection since the cost of a comprehensive policy may be prohibitive, and each type of policy has numerous exceptions to coverage. Instead, you should use insurance as one of a multiple layer of strategies designed to place a barrier between your business and personal assets and the claims of a plaintiff. Moreover, it is important to work with an insurance professional who can explain the purpose of each type of coverage, make recommendations for liability limits and deductibles, and help you consider the most cost-effective coverage on an annual basis.
Tip #2 – State Law Exemptions Protect a Variety of Personal Assets from Lawsuits
Each state has a set of laws or constitutional provisions that partially or completely exempt certain types of assets from the claims of creditors. While these laws vary widely from one state to the next, in general, the following types of assets may be protected from a creditor seeking to enforce a judgment against you:
● Primary residence (referred to as “homestead” protection in some states)
● Qualified retirement plans (401(k)s, profit sharing plans, money purchase plans, IRAs)
● Life insurance (cash value)
● Property co-owned with a spouse as “tenants by the entirety” (only available to married couples; and may only apply to real estate, not personal property, in some states)
● Prepaid college plans
● Section 529 plans (“college savings plan”)
● Disability insurance payments
● Social Security benefits
Planning Tip: If you reside in Maryland or the District of Columbia, Miller, Miller & Canby’s attorneys can help you determine which exemptions are available to you and how much protection they provide. Our business and estate planning attorneys can also help you understand the pros and cons of each type of exemption. For example, while tenants by the entirety co-ownership of real property between you and your spouse is simple and may make sense in the short term; in the long run, if you divorce or one spouse dies, the protection provided by tenants by the entirety co-ownership ends, thus making it completely useless. As with liability insurance, exemption planning is best used as one layer of an overall asset protection strategy.
Tip #3 – Business Entities Protect Business and Personal Assets from Lawsuits
The various types of business entities include partnerships, limited liability companies, and corporations. Business owners need to mitigate the risks and liabilities associated with owning a business. Business entities can also help real estate investors mitigate the risks and liabilities associated with owning real estate. The right structure for your enterprise should take into consideration asset protection, income taxes, estate planning, retirement funding, and business succession goals.
Business entities can also be an effective tool for protecting your personal assets from lawsuits. In many states, in addition to the protections offered by incorporating, assets held within a limited partnership or a limited liability company are protected from the personal creditors of an owner. Depending on the type of business entity and the state of formation, the personal creditors of an owner may be prevented from taking control of the business. Instead, the creditor is limited to a “charging order” which only gives the creditor the rights of an assignee. This is beneficial to the owners, because an assignee generally only receives distributions from an entity if, and when, the distributions are made.
Planning Tip: Creating a business entity that protects your assets from lawsuits involves much more than just filling out some forms with the state and paying an annual fee. Business formalities must be observed and documented, otherwise a creditor can attack the entity through “veil piercing” or “alter ego” arguments, which could result in personal liability for your business’s actions or debts. Additionally, state laws governing business entities vary widely and are constantly changing due to legislative action and court decisions. As a result, it is critical to properly chronicle business activities and modify the business’s governing documents as applicable laws change.
Miller, Miller & Canby’s business law attorneys can help you remain in compliance to thwart any potential challenges to your entity. And remember, as with liability insurance and state law exemptions, the use of business entities is just another layer of an overall asset protection strategy that should coordinate with other asset protection strategies.
Protecting Your Assets
We highly recommend that liability insurance, state law exemption planning, and business entities be used together to create a multi-layered asset protection plan. The business & estate planning attorneys at Miller, Miller & Canby are experienced with helping business owners, real estate investors, board members, retirees, physicians, practitioners, and others create and maintain effective liability protection plans.
David A. Lucas is an attorney in the MM&C's Estates & Trusts and Business & Tax practice groups, focusing his practice in Estate Planning, and Trust and Estate Administration. He provides extensive estate and legacy planning, asset protection planning, and retirement planning. To learn more about Miller, Miller & Canby's Estates & Trusts practice click here.
Chris Young is an associate in the Business & Tax practice at Miller, Miller & Canby. He focuses his practice on corporate legal agreements, business formation, tax controversy work and helping clients deal with new tax regulations. View more information about Miller, Miller & Canby's Business & Tax practice by clicking here.
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