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Can Your Assets Survive a Lawsuit?

Agony of DefeatThe way you hold title to your property is often the determining factor to whether you will lose everything in a lawsuit. You can be sued more and more today because of your “legal status,” not because of your “actions.” The trend is away from finding fault. This is due to the  significant expansion of both “vicarious liability” which allows you to be sued for something someone else did, and “strict liability” which means you are automatically liable by statute and there is no defense.

Here are some distressing examples:

In environmental law, you do not have to be the person who made the mess. If you were ever in the chain of title, you can be sued after discovery of the environmental situation. For example, lead paint damage is a “strict liability” offense. And you will almost certainly find that your insurance excludes coverage for lead poisoning. This can destroy retired people.

If you have put all of your assets into a trust and one of the assets in the trust is sued (example: lead paint liability) then you could lose everything in the entire trust. (Remember, the purpose of a trust is to avoid probate. A trust cannot shield your assets from legal attack.)

If you are an employer you can be sued for the actions of your employees committed while acting within the scope of employment. “Negligent hiring” is the latest hot winning theory to confer liability onto an employer for actions taken by an employee outside the scope of employment. This occurs when an employee commits a wrong or violence against someone following an employer’s failure to research the background and character of the employee before hiring the person.

On June 26, 1985, the Supreme Court said that you could lose an asset due to joint ownership. As an example, if Mom and Dad put their home into a joint tenancy with their kids to avoid probate (often referred to as a “poor man’s will”), and any of the joint owners (the kids) is involved in a divorce, loses a lawsuit, or gets in trouble with the IRS – Mom and Dad could find themselves homeless. 

If you are involved in a “general” partnership and your partner sends his daughter on an errand, and the daughter happens to get into an auto accident and harm someone while on that errand – you are liable.

Divorce. Need I say more?

Retired health care professionals can be sued today for something that happened many years ago, because often the statute of limitations starts running from the date of “discovery.”

If you serve or have served as a corporate officer or director (or an “implied” corporate officer or director – such as where a spouse helps out by occasionally writing checks for the other spouse’s corporation) you can be sued for simple negligence in most every state but Nevada.

Just owning an asset can subject you to liability. You are liable for what happens on your property, and considered a “deep pocket” if you own any.  For example, you are vicariously responsible for guest accidents in your home.

Solution?  Change your legal status by converting the form of your assets into something difficult to reach, and build a firewall between assets.  It is not immoral or unjust to insulate yourself, your assets, your business and your family against attacks.

Property held by either a for-profit or not-for-profit corporation, a “general” partnership, a living trust, or held in joint tenancy or individually, may be seized by a judgment creditor, which is why it is not advisable to hold real property in those entities.  (As a matter of fact, any second  year law student can recite at least a dozen ways to “pierce” a corporation and thus go after it’s assets.)

The consummate lawsuit protection entity available today is an advanced application of the “limited” partnership (LP). With over 90 years of case law behind it, real property held in a correctly drafted and skillfully structured LP is well protected (often referred to as a “Family Limited Partnership” or FLP by asset protection attorneys). Note, not just any old LP will do.  Most LPs are designed and drafted to protect the limited partners, not the general partners (you) and your assets.  So it takes some skillful drafting by a specialized asset protection attorney.

The purpose of holding your assets in a properly structured and drafted LP is that if you are ever sued and lose the lawsuit, then, (under the Uniform Limited Partnership Act as adopted in 49 states) all the plaintiff can get is a “charging order” against the income portion of your  limited partnership interest. The plaintiff (who becomes a “judgment creditor” after a successful lawsuit) will not become a substituted partner, will have no voting rights in the limited partnership, cannot remove you as a general partner – so you continue in 100% control of the assets, cannot force you to dissolve the LP or distribute profits, cannot force you to sell or liquidate assets to pay the creditor, and only if the general partner(s) decide to distribute profits will the judgment creditor receive anything except (under IRS Rev. Rule 77-137) the right to pay income taxes on the income “earned” by the LP – whether or not that income is distributed!

Warning! Your popularity as a potential “deep-pocket” defendant could significantly suffer as a result 🙂

If you can afford to hire a sophisticated asset protection attorney, it is advisable to get your assets into FLPs a.s.a.p. and then complete your estate planning by putting your FLP ownership interests into your Family Trust.

My second choice of asset protection entity is a Limited Liability Company (LLC) with more than one member.  LLCs were born in Wyoming a couple dozen years ago, and then quickly spread throughout the other States.  LLCs are popular because they were invented to combine the best parts of corporation law (without all the paperwork, meetings and hoop-jumping) with the best parts of partnership law.  LLCs are easy to form and easy to understand and operate.  LLCs also have the benefit of requiring your creditors to obtain a “charging order” just like creditors who become judgment creditors of an FLP (see discussion above).

If you are an income property owner, you should get your assets protected immediately!

How many LLCs you form is up to you.  When I was practicing asset protection law, some of my clients would put multiple rental properties in one LLC and some would build a new LLC for each rental property (example: 123 Main Street, LLC or Hilltop Apartments, LLC).  It depends on your risk tolerance and the configuration of your properties.  Obviously, if you have a 36-unit apartment complex, it probably makes sense to have one LLC as it’s owner.  If you have a bunch of houses you might want to group a few together in one LLC or you could create an LLC for each one and thus insulate each one from the others.  Remember that you will be keeping books, records, bank accounts, and filing a tax return for each entity so you have to balance asset protection with ease of conducting business as well.

Often your biggest risk years will be your early years as an income property investor/landlord because you simply won’t know where all the landmines are buried.  As you become more sophisticated and educated and experienced as a landlord, your risk will likely decline, but you’ll know enough by then that you wouldn’t be caught dead without appropriate ownership entities for your properties.

In conclusion, landlords are in a position of high vulnerability to lawsuits.  Getting your assets situated in LLCs (or advanced FLPs) may help you sleep almost as well as a clean conscience and a pure heart.

Don’t put it off!

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