A basic Florida asset protection strategy for business owners is to operate a business in a separate legal entity instead of as a sole proprietorship. The main business entities include corporations, limited liability companies, and limited partnerships. Florida Statutes establish the ground rules for each of these entities and gives each entity unique legal characteristics, formalities of operation, and tax attributes.
Most owners of small businesses conduct their business in a corporation, limited liability company (LLC), or partnership. The owner’s selection of a business entity depends upon many factors including whether the business is owned within a family, whether there are outside investors, expectation of public ownership, and tax planning. Generally speaking, for purposes of protecting the owner’s personal assets from business liabilities, it makes little difference which of these three entities the owner chooses to operate the business.
In the case of a sole proprietorship, general partnership, or trust, the owner, partner, or trustee, respectively, has unlimited liability for debts incurred by the business. The legal advantage of operating a small business through a business entity instead of an individual sole proprietorship is that the business entity can shield the individual owner and his assets against personal liability from business creditors. In a properly organized, capitalized, and operated business entity, the individual owners are not responsible for the business entity’s debts and other risks. If the business breaches an obligation or causes injury to a third party, only the business (not the owners) is legally responsible.
Conducting business in a corporation, LLC, or limited partnership can have some privacy advantages. Each of these three business entities are separate “persons” for legal purposes. They have their own Federal Tax Identification Number which is separate from the owner’s social security number. Real estate, bank accounts, and other business interests can be legally owned in the entity name. The identity of corporate shareholders, LLC members, and limited partners are not required in any public filing with the Florida Secretary of State. In theory, at least, the business’s owners are private and evidence of ownership is not available for public access.
Privacy is not a feature of all businesses. For example, publicly traded companies are required to disclose the names of principal shareholders in regular reports to the Securities and Exchange Commission and Florida regulatory agencies. Professionals who conduct their business through a professional corporation (P.A.) or professional limited liability company (P.L.L.C.) are not shielded from personal liability for professional negligence, and any claim not covered by malpractice insurance may be enforced against the professional’s personal assets. A professional corporation or PLLC does protect each professional member from personal liability for damages assessed against any other shareholders or members.
Asset protection of a business entity is much different than asset protection for individuals. Individual debtors residing in Florida may protect their most valuable assets under the exemptions made part of Florida’s constitution and statutes. The individual Florida debtor is able to exempt his primary residence, many financial assets, and in many cases salary and marital property from creditor judgment. Florida’s individual asset protection exemptions are not applicable to business entities. Florida law gives business entities no exemptions from creditor’s judgments.
A significant portion of people seeking asset protection advice are business owners who have acquired wealth through entrepreneurial business ventures. Often, the business owner’s potential creditors have a claim against the business as well as the individual owner who may have signed personal guarantees of business debt or guarantees to vendors. A creditor’s successful attack upon the business’s assets can deprive the owner of current income and future wealth because if the creditor can shut down the business, it can cut off cash flow to the individual owners.
With no exemptions applicable to business entities, all of a business’s assets are at risk if a creditor obtains a judgment against a business entity. The recording of a judgment will become an automatic lien on all real estate held in a business name. A creditor can garnish all business bank accounts and other debts owed the business including accounts receivable from individuals or third parties such as insurance companies. A judgment creditor can even levy upon the business’s leases thereby depriving the business access to leased offices, facilities, and vehicles. Essential intangible property including intellectual property such as patents, software, or computer codes are exposed to a judgment creditor’s execution and levy.
Effective asset protection of business assets is more difficult and the tools more complex than protection of its owner’s assets. There are tools available to shelter a business’s most valuable assets, but those tools and planning must be implemented early and thoughtfully. Also, business asset protection may have income tax consequences, and asset protection tools may have different tax effects upon different owners of the same business. Business planning should involve an asset protection attorney, the business’s general attorney, and the business’s tax accountant.
Special Purpose Business Entities
The core of any successful business is its ongoing operations including its manufacturing of goods or provision of services to its customers, financial dealings with lenders and suppliers, and marketing to prospective customers. Most potential legal liability which a business encounters is associated with its core business. Lawsuits are likely to arise out of financial transactions or from business interactions with third parties such as customers, clients, or suppliers.
Business assets are vulnerable if they are owned by the same legal entity that operates the core business because a judgment against that business entity will threaten the same assets and thereby jeopardize business operations. Business asset protection starts by separating the ownership of essential business assets from core business operations which are susceptible to lawsuits. A core operating business can use essential assets even if the legal titles to the same assets are owned in the name of a different legal entity (such as a different LLC or corporation).
The non-core entities which own business assets are often referred to as “special purpose entities” (“SPE”). Their special purpose is to own, hold, and maintain assets that are essential to an operating business. An SPE can have legal title to real estate, intellectual property, equipment, or even accounts receivable. The SPE may lease or license its assets to the core business, and the core business pays the SPE for asset use in periodic payments of rent or license fees. These lease or license payments are tax deductible by the core business entity and are income to the SPE. A judgment against the core operating business should not endanger the assets owned by these special purpose entities.
To be effective, a business plan needs to separate business assets from the core business early in its business history and prior to threatened litigation. A business’s assignment of its assets to a separate entity can be attacked as a fraudulent transfer if it appears that the business planning was undertaken primarily to place the business assets outside the reach of creditors. Also, transfers of assets from a core business to an SPE after a business has grown may accelerate taxation of income. If the business has depreciated the asset, or if the asset has appreciated in value (such as land), then the transfer to an SPE may accelerate taxation of the amount by which the asset’s value at time of transfer exceeds it adjusted tax basis.
Special Purpose Entities
Many small businesses own commercial real estate which the business uses as offices or warehouses. A recorded judgment against the business will immediately and automatically become a lien on the business’s real estate. A business can set up an SPE such as an LLC or partnership to take legal title to business real estate at the time of purchase. The SPE can be owned by the same individuals who own the operating business. The business then will lease the building from the SPE, and the SPE will flow through to the individual business owners depreciation and other tax losses associated with the real estate.
Small business owners often underestimate the value of their intellectual property including trademarks, copyrights, and patents. A business’s intellectual property may have little value to a third party or creditor, but the same intellectual property is essential to the debtor’s business. The debtor’s business could be forced to shut down if a judgment creditor levied upon essential patents, trademarks, or other intangible property.
Some business owners warehouse large amounts of cash in business checking accounts. A judgment creditor will move quickly to garnish all business financial accounts. Bank garnishments are the easiest way for a creditor to execute a money judgment against a business. A business concerned about a potential lawsuit should keep just enough cash on hand to pay immediate obligations such as employee salaries and vendor payments. Surplus cash can be distributed to the business owners in the normal course of business. It is important to demonstrate a history of distributed profits or salary to owners because there will be fraudulent transfer issues if a business makes a one-time distribution to owners of a large amount of accumulated business cash in the face of litigation.
Alternatively, if a business needs to retain a cash surplus, the business should not hold the cash at the same bank where it maintains its operating accounts. A judgment creditor will usually know the debtor business’s primary bank from which the business writes most checks, and the creditor will quickly garnish all accounts at that bank. Creditors will not immediately know about business accounts at different banks (or even in different states) that hold business cash not used in the normal course of business. However, a judgment creditor will eventually discover all cash accounts through post-judgment discovery. Additionally, there are some banks that are very difficult to garnish under applicable law even if the creditor knows of accounts at such banks.
Office Furniture and Special Use Equipment
Normal office furniture, including desks, chairs, computers, and tenant improvements, have little value and are easily replaceable. Small-size technology equipment is portable. Most businesses do not set up a Special Purpose Entity to own only office furniture and equipment. Some aggressive judgment creditors may try to identify and then levy on general office equipment to harass the business debtor. The debtor may have to pay money to “buy back” general equipment in lieu of replacing the office equipment by lease or purchase through an SPE.
Some businesses have valuable specialized equipment which is essential to their core business services. For example, levy and sale of a business debtor’s large or specialized industrial equipment used in a manufacturing process or a commercial service can often produce significant money for a judgment creditor. A business should own valuable equipment in an SPE and lease the equipment from the SPE at market value. Fraudulent transfer and tax issues discussed above for other assets classes are similarly relevant to special business equipment.