A subspecialty for many business lawyers including myself is a legal and tax area known as asset protection. In this area, companies and other agreements are created for customers that protect them from claims by their creditors.
I feel easily guilty at times when offering asset protection services to my clients as clients don’t deserve asset protection if claims against them are legitimate. But my clients usually pay their legitimate bills; It is therefore my goal to protect them from unfounded claims, be it in the form of unfounded invoices or unfounded lawsuits. In this country anyone can sue anyone for anything, so legal protection from unfounded claims can be an important service for their customers.
The most basic asset protection for business owners is to create businesses for them that provide legal protection against claims. Business people who operate as sole proprietorships under state law, ie by sole proprietorships that are not run as companies, do not have these protective shields. This means that they will be personally liable for any third party claims against them for business acts or omissions, not only of themselves but also of their employees, if any, and sometimes even of independent contractors who work for them. And their homes, any securities they own, and all of their personal assets are at risk in these claims, with the exception of cash they hold in qualified retirement plans.
The same applies to people who do business in state-legal partnerships. People who conduct business in collaboration with other people and share the profits and losses of those businesses with them, even if they never consider themselves partners in state law and never consider themselves partners of other people, are nonetheless partners as a matter of New Hampshire law . Partners are just as personally liable as sole proprietorships under state law.
The same applies to married couples who own rental properties as co-tenants. In the eyes of the law, they too conduct their business as partners and are liable as partners.
All of the above business people should not conduct their business as sole proprietors, partners or co-owners, but in state-owned corporations or LLCs, as these companies offer them liability protection from third-party claims they need (except of course liability for claims arising from their own misconduct).
Even when business people conduct their business through corporations or LLCs, they should seriously consider doing so through holding company / operating company structures if their companies have valuable business property. This property can consist of cash, valuable real estate, valuable personal property such as machines, tools, or vehicles, or valuable intellectual property such as patents, trademarks, or trade secrets.
Through proper ownership agreements, valid assignments of ownership, or otherwise, their holding companies should hold all of these assets on their own behalf. You should lend, lease or license them to completely separate companies called operating companies. and these activities of lending, leasing and licensing their assets to their operating companies should be the only activities of their holding companies. A company’s holding company does not engage in any activities with customers or other third parties. Instead, all activities with third parties should be carried out exclusively by operational companies. In this structure, a company’s assets are likely to be fully protected from third party claims, and while their operations are at risk for those claims, they do not have assets that successful claimants can seize.
Who should the operating company of a holding belong to? Operating companies can be held either as wholly owned subsidiaries of holding companies or by companies that are often referred to as “sister companies”, that is, companies that have either some or all of the same ownership as their holding companies. Choosing between owning operating companies as a subsidiary or as a sister company can be difficult. In general, however, holding / subsidiary structures are likely to be simpler than sister company structures. However, in litigation, third party plaintiffs are likely to argue that subsidiaries of holding companies are simply their parents’ alter ego. Entrepreneurs concerned about the possibility of alter ego claims may prefer agreements with sister companies.
The bottom line is that companies with valuable assets should rarely operate through a sole proprietorship structure. Rather, they should use a holding / operating company structure. When companies have boards of directors or when multi-member LLCs are run by managers, the failure of those directors and managers to organize their businesses into holding / operating company structures can constitute serious breaches of their duty of care.
In other words, business leaders and LLC managers may also need asset protection.
John Cunningham is a Concord tax and corporate attorney. He has published “Limited Liability Company Operating Agreements” and “Maximizing Pass-Through Withholding Under Section 199A of the Internal Revenue Code”. Both are the leading books in their field.