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First LLC Mistake: You Signed the Articles!

Roger McClure June 24, 2009

Why do you set up a limited liability company (LLC)? Because you want to have at risk only the money and property you choose to put into your LLC; you do not want to risk all of your other assets if there is a failure of the LLC business. You want to limit your liability from business activities.

Example: Susan owns five rental houses, A, B, C, D and E. Susan is sued on house A which she owns in her name. She loses the lawsuit and suffers a judgment against her for $500,000. As a result, all of Susan’s assets are at risk to pay the $500,000. The person who gets the judgment against Susan (judgment creditor) uses the judgment to sell house A through a court sale or foreclosure. The net proceeds of the distress sale of house A are $50,000 and all of this goes to the judgment creditor. She still owes $450,000 to the judgment creditor. The judgment creditor has houses B, C, D and E sold at distress sale prices for total net proceeds of $200,000. Susan still owes $250,000. The judgment creditor then goes and takes the money out of the savings, brokerage accounts, home, stamp collection and other assets of Susan until she has paid the entire $500,000, plus interest, legal fees and costs.

Is the LLC the solution? Susan does not like this. She does not want her savings and other assets put at risk as a result of her investments in rental houses. Susan hears that a limited liability company (LLC) can limit her liability.

LLCs became popular in America in the last 20 years. Basically, an LLC is a legal entity you set up under state law. Once you have the LLC and you keep it in force and if there is a judgment against the LLC, the judgment creditor is only supposed to get the assets in the LLC. The judgment creditor can not come after the assets of the owners of the LLC, unless the owners contributed personally to the reasons for the judgment. Thus, if it works and all of Susan’s houses are titled in the name of Susan’s LLC, then the $500,000 judgment creditor gets all of the five houses owned by her LLC, but can not come after Susan’s savings accounts and other assets.

Personal Judgments: If Susan had an auto accident where she was found at fault and the person she injured obtained a judgment $1,000,000 against her above the insurance limits that Susan had, then Susan is personally responsible to pay the $1,000,000 that her insurance company will not pay. In some states, if Susan’s houses are owned by her LLC, then the $1,000,000 judgment creditor can not use the judgment to sell her houses.

Pre Lawsuit Asset Search.
Trial lawyers make their money by suing people and insurance companies who can pay money. The wealthy trial lawyers pick cases very carefully and will often order an asset search before deciding to sue someone. Go to the internet and search for “asset search” and you will find many companies who are ready to find out what you own for a fee. One private investigator says that he can find out what most people own in a couple of hours!

First Mistake: Susan decides to save on legal fees and files the papers for the LLC herself. This means that Susan’s name is in the public record as owning the LLC. When the trial lawyer is deciding whether to sue Susan, the trial lawyer finds through these state and local records that Susan is the owner of her LLC which owns multiple properties, making Susan a desirable target for a lawsuit. Using the internet, this may take fifteen minutes or less. The trial lawyer may be able to force a sale of the houses owned by Susan’s LLC to pay a future judgment. Susan has greatly decreased the asset protection available from the use of an LLC.

Do Not Sign the Articles. Instead, if Susan retained a well informed lawyer to file the Articles of Organization with the state, then in many states, Susan’s name would not be in the public records either for the LLC or as the owner of her houses. The asset investigator may not find out that Susan owns five houses. If an investigator calls the attorney’s office, we treat this as a private matter and subject to the attorney client privilege. We don’t tell the investigator who owns her LLC unless Susan instructs us to tell the investigator. Normally, there is no legal right for a private investigator to force us to say who owns the LLC or LLC property before the filing of a lawsuit.

Top Ten Mistakes. Certainly, when Susan is sued, she will probably have to tell the trial lawyer what she owns, including the LLC, through the litigation process. But, if Susan does not make the First Mistake, she may not be sued in the first place. But, if Susan is sued and she has not made the top ten mistakes in setting up the LLC, there is a good chance of a reduced quick settlement paid entirely by insurance.

This is the First Mistake. We will take about the other Nine Mistakes in future blawgs.