Asset Protection & Single Member LLC’s: Pros, Cons, & Real-World Cases

An LLC May Not protect assets in the real world as much as it does in theory

Courts have slowly eroded Asset Protection and Single Member LLC’s by allowing creditors to reach past the LLC to the owner or owners. An LLC, by itself is probably not enough protection for the average business owner.

Asset Protection and Single Member LLC’s are very rarely synonymous in the real world despite what one hears from marketers in theory. LLC’s are great for many things, but most business owners that think that paying a few hundred dollars to designate their business as an LLC, corporation, or LLP will adequately separate business assets from personal ones. They could be gravely mistaken. In fact, unless one follows the LLC rules to the letter, chances are that personal assets are on the table in the event of a lawsuit or bankruptcy; with a single-member LLC or even sometimes with a multi-member LLC. How many LLC owners log meeting minutes for every major business decision or never pay for personal items with the company checkbook? Either one of these can form a crack in the wall in which a good attorney can drive a wedge and allow the courts access to personal assets.
What can crack the walls of an LLC? Well, lets start out with the obvious. If a person were to set up an LLC for criminal, wrongful or fraudulent purposes, that person could be held liable for debts of the LLC. A little less obvious and more confusing is that courts have also looked passed LLC’s to personal assets by calling them “alter egos.” Basically, the court is saying that the LLC is just a business in name but actually just the owner in disguise. If the LLC is actually the owner, collecting debt from the LLC is also collecting debt from the person’s college fund for their children. Here’s one that perplexes. If the LLC is not adequately funded, then the court can go after personal assets. Most business owners start out with almost nothing and grow their business. Are the courts saying that someone is not protected while their business is growing? Maybe the courts are urging business owners not to protect their businesses with an LLC until they are larger? Either way, the current state doesn’t encourage startups or risk taking and the LLC doesn’t seem to be the answer, at least on its own.
If a business doesn’t hold up to a court’s scrutiny, the owner and the owner’s family could lose everything. In fact, here are some examples of just that:
In this case, young girl drowned in a public swimming pool owned by an LLC. The father of the deceased sued the LLC and asked the court to set aside the LLC for a judgment against the single-member of the LLC. The Supreme Court of California found a way around the LLC by determining that the LLC did not have enough assets to conduct a public swimming pool. The owner of the LLC, became personally responsible for the award in the lawsuit. Sometimes a horrible event happens like this and often courts will try to right the wrong, even when it takes a little bending of the law.
Another single-member LLC falls. Even after the LLC was essentially dissolved, the court could still go after the owner. In this case, Tradewinds group, a single-member LLC, contracted to have Martin construct an airplane hanger. Tradewinds eventually sued Martin for breach of contract and won. Martin appealed and the case was sent back to the court where the decision was reversed and Martin was awarded substantial litigation costs. Tradewinds had sold its assets to Freeman, the owner of Tradewinds. Martin went to court to disregard the LLC to collect from Freeman personally. The court found that Freeman was an “alter ego” of Tradewinds so they were one in the same. Freeman was held personally accountable for the judgment.
Even a multi-member LLC that fails could hide threats to one’s personal assets. Do you think personal assets are safe after an LLC files bankruptcy? This case involves a multi-member, closely held, LLC that declared Chapter 7 Bankruptcy. The trustee of the bankruptcy estate attempted to hold the members of the LLC personally responsible for debts. The court found that the members were personally responsible for several debts as they had “dealt with creditors personally” (How else would one do it?) and did not explicitly identify themselves as an agent of the LLC.
In this case, a single-member LLC entered into an agreement with the purchasers of a home to finish the home in certain amount of time. The LLC failed to do so. The purchasers successfully sued the LLC. The purchasers then targeted their sights on the assets of the owners. The court ruled that the LLC was intermingled with other entities and personal assets and is therefore to be disregarded and the owners were personally liable for any court awards. This illustrates that when the owner of an LLC neglects to follow the strict separation rules between personal and business assets, they can also endanger their personal assets.
In this case, an amateur softball association sued a single-member LLC over trademark infringement also naming the owner in the suit. The court ruled that the owner was personally liable because trademark infringement was simply enough to warrant it as a fraudulent act! This illustrates that sometimes courts will even make rulings that are so broad that one wonders why bother with an LLC at all.
In this case, a power company sued a single-member LLC. The power company attempted to collect from the owners of the LLC under a by piercing the veil of the LLC. The court found that since there was not enough funding, spaces were used for personal and business uses, they did not file annual reports, they did not file property records, or file tax returns, that the owners were liable for the award from the court. This illustrates that when an LLC is determined by the court to be “underfunded,” the court may find that that the LLC was just a front for the owner.
All of these cases illustrate a single powerful point. When something bad happens, an LLC by itself may not protect personal assets. A good lawyer will pour over all of the LLC documentation and generally will find something to start that crack in the wall. Even if they don’t succeed, they can use that crack to scare an owner or owners into a larger settlement. An LLC or LLP is a good thing, but, one wrapped in an UltraTrust can stop that crack before it even starts.
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