Over a million lawsuits are filed in state courts every year. And, according to one source, all of us have a 10% chance of getting sued in any given year and a 33% chance of getting sued during our lifetimes! This is scary information given that being on the losing end of a lawsuit can be financially devastating.
As a business owner, you have special cause for concern. That’s because if your business is sued and ordered to pay a money judgment as a result, the plaintiff in the lawsuit can collect on the judgment not only by going after its assets, but by going after your personal assets too if your business does not have enough resources to pay the full judgment amount.
The good news however, is that appropriate up-front planning can protect your personal assets. For example, you can:
- Purchase adequate liability insurance
- Structure your business appropriately
- Minimize the amount of cash in your business
- Take advantage of the asset exemptions provided by the law in your state
Have Adequate Insurance
Adequate liability insurance is essential. Consider it your first line of defense in the event of a lawsuit.
The insurance you buy should cover the standard risks your particular type of business faces. For instance, if you are operating a trucking company, having commercial “car” and “truck” insurance would be smart while if your business is in advertising, coverage that protects it from slander or libel and even copyright lawsuits would be appropriate. And if you are a professional, like a realtor, doctor, dentist, lawyer, engineers, and the like, you must have malpractice insurance, sometimes called “errors and omissions” insurance. Consult with a qualified insurance agent about the specific insurance you need as well as the amount of coverage you should have.
It’s important to understand however, that insurance won’t protect you from every possible risk, and that the amount of insurance your business can afford may not be enough to pay the full amount of a court judgment. It’s also possible that your insurance policy won’t cover certain kinds of claims. For instance, it may not cover a sexual harassment claim.
Choose the Right Business Structure
Structuring your business appropriately is another extremely important line of defense. For example, it’s not a good idea to operate your business as a sole proprietorship or as a general partnership because these two forms of business will put your personal assets at risk.
Far better options are to set up your business as a Corporation, an LLC (Limited Liability Company) or as a Limited Partnership. All three legal structures will help ensure that if your business is sued and looses, the plaintiff will not be able to go after your personal assets should your business not have enough insurance to pay the full judgment amount and cannot make up the shortfall itself, or if the reason for the lawsuit is not covered by your business’ insurance.
Be aware however, that if your business is a corporation, its stock can be seized if you are sued personally. In contrast, ownership interests in an LLC and a Limited Partnership cannot not be taken should you or another owner be sued. It’s a good idea therefore if your business is incorporated, to seriously consider converting it to one of these other two business structures.
Consider Additional Personal Asset Protection
You may also want to set up an LLC that holds your personal, not business, assets. This kind of LLC is often used to protect rental and recreational property as well as large investment accounts from being seized to satisfy a court judgment.
You will need a separate LLC for each type of asset however. For example, separate LLCs for each piece of real estate and another LLC for your non-real estate investments.
If this is of interest, consult with either an estate planning or business attorney. Don’t try to set up an LLC on your own, using an on-line program or even with the help of a CPA. Although LLCs may seem simple to set-up, they are in fact, quite complex. Without the appropriate professional assistance, you may find that your LLC does not protect your personal assets as you expected should your business be sued.
Do not keep any more cash in your business than is absolutely essential – just enough to fund its day-to-day operations. This is because if your business is sued and loses, it will be very easy for the winner to go after the cash. Furthermore, once a lawsuit is pending, expected or threatened, it will be too late to move the cash out of your business because the law prohibits you from hindering a plaintiff from seizing assets that may be available to pay a claim. In other words, if you have money that is not already protected (money sitting in a company that’s being sued), you cannot “hide” it from the plaintiff. Doing so is considered a fraudulent transfer.
It’s best to keep all non-essential cash in an LLC that is owned by you (and/or your partners), not the company. That way it will be protected from your business creditors. And if the business needs additional cash to fund its operations, you can always take it out of the LLC and either contribute or loan the money to the company.
Take Advantage of Exemptions
Every state has a list of “exempt” assets — assets that cannot be taken in a lawsuit. Depending on your state, they may include retirement accounts, and with some limitations, insurance products, like life insurance and annuities as well as a portion of the value of your homestead. By the way, although the full value of a homestead is exempt in Florida and Texas; the amount of the exemption in most other states very limited.
It can be a good asset protection strategy therefore, for business owners to invest some of their available cash in exempt assets. However, always do this in consultation with an attorney in your locale who practices in this area of the law — an estate planning or business attorney, for example.
A good offense always starts with a good defense. Although you cannot have 100% control over whether or not your business will be sued some day, with the appropriate advance planning, you can control whether your personal assets will be at risk should a lawsuit happen and your business loses.
Be sure to plan all aspects of your defense with the appropriate professionals, however. Consult with a property and casualty insurance agent so you can be sure that you have all of the coverage you need, and work with an experienced estate planning or business attorney to ensure that your business is structured appropriately and that you take advantage of the asset exemptions available in your state.
This article was originally written on October 3, 2019 and updated on July 18, 2022.