In a perfect world, the bad guys would never come after us and claim unforeseen, unintended or imaginary damages. But we don’t live in a perfect world.
I once heard it stated that the top three retirement strategies for the average American are: 1) win the lottery; 2) inherit money; and 3) win a lawsuit. That is really sad, in my opinion. Not only are the first two never going to happen, the saddest part is that you may be part of someone’s retirement strategy.
Another unfortunate fact of life: your chances of being sued can be less dependent on what you did or didn’t do, than on how much you own that the bad guys can come after. The trick here is not to get rid of the things you own, but to hold your assets in such a way that they can’t be attached.
Say, for example, you own a rental property in your name individually. Your tenant can sue you personally and attach everything you own that is not otherwise protected from the bad guys.
A common misperception is that owning your assets in a living trust or family trust will give you asset protection. It doesn’t. There are very effective and affordable ways to protect your assets, but a living trust is not one of them.
Holding your assets in a corporation is not as effective as holding your assets in an LLC. While a corporation can be effective for protecting you from your tenants, someone who sues you individually (for an injury sustained in car wreck, for example) and wins, can soon own your corporation and your rental.
For rental properties, LLCs are still the best bet for asset protection. If you own multiple properties, you can create a single “series LLC,” have only one filing fee and save on other costs as well.
So let’s say that you’ve done the smart thing and are holding your rental in an LLC to protect yourself from an unscrupulous tenant (and yes, there are some of those out there). If something unfortunate happens on the property and your tenant is injured (or often, claims to have been injured), he cannot sue you personally, provided that you have properly created and are operating your rental through your LLC. The good news is that your other assets will be free from the claims of the tenant. The bad news is that you could lose your rental property. In a future article, I’ll discuss some “equity stripping” strategies on how to minimize your exposure on rentals and protect your equity in your properties.
Many people have a false sense of security because they have an umbrella insurance policy for several million dollars. An advantage of umbrella policies is that they are relatively inexpensive for a healthy amount of coverage. Unfortunately, many don’t cover rental properties. If you have one, you should check with your insurance agent to make sure it covers what you think it does.
Another unintended result of having a ton of insurance is that it actually increases your chance of being sued. It is, in essence, a lightning rod which attracts litigation, rather than a force field that deflects it. How so? There is a bigger pot of gold at the end of the rainbow. For example, John Doe has no insurance. Jane Dough has a $3,000,000 insurance policy. Under similar extenuating facts, who is more likely to be sued?
I am not suggesting that you should not have insurance. What I am saying is that you need the proper amount of coverage for your rental and whatever other business ventures you may have—not too much and not too little.
In this imperfect world in which we live, one of the unfortunate facts of life is that the more you have, the more likely you are to be sued. As my father used to tell me, “You’re not paranoid if they really are out to get you.” Sadly, if you have some assets, sooner or later you may well be the target of some unscrupulous claimant who sees you as an important part of his retirement plan.
So the moral of the story is that in our day and age, it simply is a prudent practice to take some simple steps now to protect yourself and your assets from the unforeseen and unexpected.
Back t o y our r ental p roperty. S imply holding your rental in your LLC may not be good enough. Do you have your Operating Agreement in place? D o you hold annual and other meetings? Do you keep minutes of your meetings and accurate books and financial records? Have you issued membership certificates from your LLC to evidence ownership of your LLC?
Do you have a separate bank account in the name of the LLC from which you transact all business relating to the property? Do your tenants make their rental checks or deposits in the name of the LLC? Do you deposit all checks into that account? Do you pay your taxes, insurance, mortgage payments, assessments, HOA fees, accounting and any other expenses from this account? Are you careful not to pay any personal or other expenses from the business account?
If you don’t treat your LLC as a separate and independent business entity, you may have unwittingly opened the door for a claimant of yours to break through and “pierce” the corporate (entity) veil under an “alter ego” theory. Essentially, if you don’t honor your LLC, a claimant need not either.
Simply filing articles online with the Secretary of State’s office is not enough. You need to take steps 2 through 10 in establishing your LLC, and not simply stop after step 1.
Getting everything in place is relatively simple and cost-efficient. It’s crucial that you dot your “i’s” and cross your “t’s” in doing all the little things that make your LLC work like you intended.
You can never prevent anyone from suing you. What you can do is take simple and reasonable steps now to make sure that you take all the fun out of someone coming after you, by having all of your assets adequately protected.
In coming articles, I’ll discuss various ways to protect your other assets and make it less enticing for the bad guys to sue you.