As
frequent targets of lawsuits, business owners should develop and maintain a
plan to protect their personal assets and the assets of their businesses from
judgment creditors. Although insurance
in its various forms (automobile, homeowner’s, life, malpractice, D & O and
umbrella) continues to be the cornerstone of any asset protection plan, prudent
Virginia business owners should consider additional strategies to protect their
assets in the event that insurance coverage is denied[i]
or is inadequate.
Although
asset protection plans can be complex and expensive to establish and maintain,
much can be achieved with simple, cost-effective asset protection
strategies. Four such strategies are set
forth below.
The Bottom Line: While
maintaining adequate insurance continues to be the cornerstone of any asset
protection plan, prudent Virginia business owners should consider additional asset
protection strategies in case insurance coverage is denied or is
inadequate. Specifically, Virginia
business owners should: if married, hold title to significant assets (such as
their home) jointly with their spouse as “tenants by the entirety”; establish a
retirement savings plan that affords statutory protection from creditors;
utilize Virginia limited liability companies rather than corporations to take
advantage of the “charging order” protections afforded Virginia limited
liability companies; and transfer “hot” assets to distinct legal entities to
isolate them from other business assets.
STRATEGY
NUMBER 1: “Tenants by the Entirety”
Virginia
is one of twenty-six states that recognizes the concept of “tenants by the
entirety,” a special form of holding title to property available exclusively to
married couples.[ii] Both real property and personal property may
be held as “tenants by the entirety.”[iii]
From the perspective of asset protection, the primary advantage of spouses holding property as “tenants by the entirety” is that property so titled is exempt from the claims of creditors of just one spouse. Property held by spouses as “tenants by the entirety” is only subject to the claims of creditors of both spouses jointly.
Notable limitations of holding property as “tenants by the entirety” include: (i) the fact that, in the case of real property, one spouse cannot sever his or her interest in the property[iv]; (ii) protection from creditor attack ends upon the death of one spouse; and (iii) protection from creditor attack ends upon dissolution of the marriage.
Despite
some limitations, married Virginia business owners should consider
holding title to important personal assets (such as their home) jointly with
their spouse as “tenants by the entirety.”
STRATEGY
NUMBER 2: Statutorily Protected Retirement Savings Plans
Retirement
savings plans afford different levels of asset protection depending upon whether
or not the retirement savings plan is a “qualified” plan for purposes of the
federal Employee Retirement Income Security Act (“ERISA”). In general terms, ERISA “qualified” plans
include employer-sponsored plans such as 401(k) plans and defined benefit
plans. IRAs and other plans that do not
cover employees are not ERISA “qualified” plans.
ERISA
mandates that the documentation for every ERISA “qualified” plan contain an
“anti-alienation” provision which prohibits the transfer of fund assets to any
person other than the plan participant, except in limited circumstances such as
property division in the case of divorce, attachment for child support and
federal tax levies.[v] This provision has been interpreted as
prohibiting all other forms of attachment, garnishment, levy, or other legal or
equitable process being brought against a plan participant’s fund assets.
ERISA
contains a provision expressly superseding all state law.[vi] As a result, subject to the limited
exceptions enumerated in the immediately preceding paragraph, assets in
an ERISA “qualified” plan are exempt from creditor attack. There is no dollar limit on this exemption.
Asset
protection for IRAs and all other retirement plans that are not ERISA
“qualified” is governed solely by state law.
The Virginia Code provides that an individual’s interest in a retirement
savings plan is protected from creditors to the same extent that an
individual’s interest in a retirement savings plan is protected from creditors
pursuant to the federal Bankruptcy Act.[vii]
This creditor protection does not apply
in the case of child or spousal support claims[viii]
and the dollar amount of creditor protection for retirement plans that
are not ERISA “qualified” is currently capped at $1,360,800.[ix]
Although
the complete exemption from creditor attack makes an ERISA “qualified” plan a
superior choice from an asset protection perspective, ERISA “qualified” plans
are costly to establish and maintain, requiring the involvement of consultants,
actuaries and specialist lawyers to ensure strict compliance with ERISA’s
byzantine rules and regulations.
Whether
ERISA “qualified” or not, a statutorily protected retirement savings plan
is an asset protection “must” for every Virginia business.
STRATEGY
NUMBER 3: Limited Liability Company “Charging Order” Protection
This is not the case for membership
interests in limited liability companies organized pursuant to the Virginia Limited
Liability Company Act (the “VLLCA”).
The VLLCA expressly provides that the “exclusive remedy” of a
judgment creditor against the membership interests of a debtor is
a “charging order”[x] pursuant to which a judgment creditor
will only have the right to “receive any distribution or distributions to which
the judgment debtor would otherwise have been entitled in respect of” the debtor’s membership interest.[xi]
As a result of the “charging order”
provisions of the VLLCA, a debtor may frustrate collection by a judgment
creditor by limiting distributions from the limited liability company. A debtor engaging in this strategy should
anticipate an attempt by the judgment creditor to “pierce the corporate veil” by
arguing that the limited liability company in question is just the “alter ego”
of the debtor and should be disregarded, exposing the assets of the limited
liability company to the judgment creditor.
To ensure the integrity of the limited
liability company, the debtor should take all steps necessary to maintain the
separate existence of the limited liability company. Specific steps to be taken
include having an Operating Agreement, observing all corporate formalities
required by the Operating Agreement and the VLLCA, maintaining a
separate bank account and documenting all transactions between the limited
liability company and the debtor.
The “charging order” provisions of the
VLLCA prohibiting the seizure of limited liability company membership interests
and limiting a judgment creditor’s recourse to distributions on membership
interests makes a properly organized and maintained limited liability company a
particularly effective asset protection vehicle.
STRATEGY
NUMBER 4: “Hot” Asset Isolation
Certain
assets present a higher risk of lawsuits.
A recent survey by a noted insurance consultant found that “human
assets” pose the greatest litigation risk to small businesses in the United
States. Specifically, actions brought by
employees alleging “employment discrimination and wrongful termination” and
“wage law violations” are, respectively, the number one and number three most
common sources of lawsuits faced by small businesses in the United States.[xii]
Tort
cases, including claims for personal injury brought by employees, customers,
suppliers and others and breach of contract actions account for, respectively,
the fourth and fifth highest number of lawsuits brought against small
businesses in the United States. Actions
initiated by governmental agencies tasked with the enforcement of environmental
protection, workplace safety and other laws and regulations also pose a
litigation risk.
Assets
that present an increased risk of legal liability—so-called “hot” assets—should
be isolated from a businesses’ other assets and primary sources of revenue. For example, rather than having a business
entity hire employees directly, a business owner may wish to create a new, separate
entity to hire employees and then have the new, separate entity “employer”
enter into an “Employee Leasing Agreement” with the existing business entity. In the event of an employment-related
dispute, the appropriate defendant would be the new, separate entity with
limited assets.
Similarly,
an owner of a business with a transportation component could establish a new,
separate entity to own all vehicles used in the business, leasing them back to
the existing business entity. In the
case of real property, a new, separate entity could be established to own all
business-related real property, leasing all such property back to the existing
business entity.
It can
reasonably be expected that plaintiffs in legal actions involving “hot” assets
will attempt to “pierce the corporate veil” by arguing that the new. separate
entity holding and/or operating the “hot” asset is just the “alter ego” of the
existing business entity and should be disregarded.
To
ensure the integrity of any structure involving the isolation of “hot” assets,
it is critically important that every effort be made to observe and maintain
the distinct existence of each separate, new entity holding and/or operating
“hot” assets. Specific steps to be taken
include observing all required corporate formalities, maintaining separate bank
accounts, and documenting all transactions between entities.
If
properly organized and maintained, a structure involving the isolation of “hot”
assets can provide significant asset protection benefits to Virginia business
owners.
* *
*
Should
you have any questions regarding the contents of this Client Note, please
contact Steven G. Thompson by e-mail at sthompson@sgthompsonlaw.com or by telephone
at (757) 253-5711 (Office) or (917) 817-2720 (Mobile).
[i] In the words of
Professor Stanley Schiff (deceased), a scholar whose primary research interest
was Civil Procedure: “Insurance companies are in the business of NOT
paying.”
[ii] Va. Code § 55.1-136
[iv] Va. Code § 55.1-136(B)
[v] 29 U.S.C. § 1056(d)(1)
[vi]
29 U.S.C. § 514(a)
[vii] Va. Code § 34-34(B)
[ix] 11 U.S.C. § 522(n)
[x] Va. Code §
13.1-1041.1(D)
[xi] Va. Code §
13.1-1041.1(A)
[xii] Bonner, Marianne.
“5 Most
Common Lawsuits.” The Balance Small Business, May 8, 2019, https://www.thebalancesmb.com/five-most-common-lawsuits-3886658
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