One of the many reasons for owning a “company” of some sort is corporate asset protection. Not only can company structures shield an owner’s personal assets from tort, contract or government levy, but one company can be used to protect company-owned assets from another related company’s liability.
How Does This Work?
Let’s say a person operates a business with the potential for a large liability against it, say, a commercial bus line with 15 buses. There may be several sources for potential liability. The obvious is if a patron gets hurt while riding the bus, or if a bus collides with another vehicle. There may be contract liability if the bus is unable to fulfill the client’s needs, such as ferrying event-goers from a hotel to the airport. There may be government liability for operating without proper licenses, insurance, or safety equipment.
Any one of these liabilities could result in one or more of the fleet being seized and sold to satisfy a levy. Is there a way to potentially protect the fleet from seizure, so that if the operations of the business result in a loss, nevertheless the valuable assets remain available to the owner?
The solution is to separate the -asset- from the -use- of the asset.
One company (it could be a corporation, LLC, partnership) owns the buses. A different company uses the buses. The second company gets access to the buses through a lease. The chart shows how this could work (although there are other set-ups possible):
In our case, Holding Company’s business is to purchase and lease buses. That’s all it does. Because it doesn’t do much of anything except own the buses and lease them out, it has very little exposure to the outside world, and thus, very little potential liability.
Operating Company’s business is to use those buses for transport – it is a transport for hire business. It may even undertake to maintain the buses to further shield Company HC from allegations of improper maintenance; in fact, I would even throw an indemnity/additional insured obligation onto OC as part of the lease. Company OC has very little in the way of assets, but has all the exposures discussed above. If Company OC gets hit with a levy it can’t satisfy, it can shut down or file bankruptcy. Company HC will still own the buses, and will retake possession when OC shuts down.
Another example of the type of business that could benefit from this structure is a doctor’s partnership that also owns the office building in which they work. The M.D.’s would set up the operating business to provide medical services; and a separate company to own the office building and lease it to the doctors.
In order for corporate asset protection to work, however, there needs to be clear and consistent separation between the two businesses. They need to be formed separately, have separate operating documents, and separate shareholder / BOD meetings. They should have their own phone number, web site and email; logo, billing systems, tax filings, profit or loss taking, employee and salary obligations. Just as important, there should be an arm’s length relationship between their business dealings, just as if they were not related businesses: a formal, written lease; consistent billing; valid and appropriate payment for the lease. A good test for this would be if the owner could sell one business on the open market without interrupting operations of the other.
This corporate asset protection scheme is tricky business to set up and maintain properly, but it’s not a scam or shady – it’s done by some of the largest businesses in the country and it’s perfectly legal. Wal-Mart for example has split off its real estate holdings from store operations. The only problem may arise if some judge decides to ignore the relationship between the two companies and allow attachment of the assets for debts of the operating business. That can’t be helped or predicted, unfortunately.
If you think your business could benefit from an extra layer of corporate asset protection from the potential liabilities of the operating aspects, and you’re located in Western North Carolina or the Chicago area, call me for business law advice at (312) 671-6453 for legal advice.