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Why LLCs, FLPs and Corporations Are Just Hors D'oeuvres

By Rob Lambert - Email Editor

Date: Feb 16, 2006

In law school, my corporate law teacher always said that corporations and partnerships (he meant limited partnerships) were good because they “insulated their owners from liability.” Implicit in this promise of insulation was the ability (for a small fee!) to give a client the comfort that the entity would keep them from being sued.

NOTHING COULD BE FURTHER FROM THE TRUTH.

Today I am going to take on a fundamental misunderstanding. It is commonly thought that FLPs, Corporations and LLCs (they didn’t even have LLCs when I went to law school) will insulate you and your assets from the omniscient and seemingly omnipresent professional taker: the contingent fee tort lawyer. This is simply wrong.

These wonderful and very valuable entities are great for many purposes. They are NOT great at insulating their managers from being sued when things go bad at the entity level. For example: If you are an orthopedic surgeon and own 100 shares of Krispy Kreme, you are not going to be sued when some customer is burned in a grease fire. HOWEVER, if you are an officer of Krispy Kreme, or even worse, a manager at the store where the fire occurred, you ARE going to be personally sued. If you are sued, and the loss isn’t covered by insurance, your home, cars, savings and everything you own is potentially available to your creditors. When you see the tow truck pick up your brand new BMW, you will quickly realize that the much-touted “corporate veil” wasn’t worth the powder to blow it up.

In this day and age when many of us operate small businesses, it is important for us to also realize that the entities we are told provide us insulation from lawsuits do not. If we are personally involved with the operation of the business in any way, we are just as much on the firing line as if we never incorporated or formed that LLC or FLP.

Well then, why do I like LLCs, FLPs and Corps? Simple. Although they don’t always insulate you from exposure to lawsuits, they do many other things well: two in particular.

1. They are great entities to divide and conquer. My long time readers know that I think that each and every investment asset should be owned in a separate entity. If you own a donut shop, an apartment, and a stock portfolio, for heaven’s sake, make sure each is in a different entity (any will do, and the specific form you choose will depend on many factors, including tax issues). That way, a slip and fall at the donut shop is unlikely to expose the apartment or investment portfolio. Why? Because even though it is pretty easy to go “up” to the owner/manager of the donut shop, it is much harder to go “down” to the investment portfolio or apartment house (more on this in a later newsletter).

2. Limited Partnerships are great entities to separate ownership from control. Note: LLCs are not and Corporations are generally useless in this regard. Separating ownership from control is an important issue especially if you involve an Asset Protection Trust in the planning, as you want to always make sure that the Trust has no control at all. This is the subject of an entire future newsletter.

I hope this is a helpful Asset Protection “tid-bit.”

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