Creditors and predators

Purposefully structuring your assets will limit your liability exposure

According to the National Center for State Courts, nearly 20 million lawsuits are filed every year in the U.S. Many of these lawsuits are regarded as "frivolous," meaning they have little merit based on facts. Frivolous lawsuits typically have the intent to intimidate defendants and seek cash settlements instead of a trial.

Senate Judiciary Committee Ranking Member Chuck Grassley (R-Iowa), a proponent of lawsuit abuse reform and sponsor of the Lawsuit Abuse Reduction Act of 2011 that addresses meritless litigation, says the annual direct cost of U.S. tort litigation exceeds $250 billion.

Why so many lawsuits?

The reasons for the overwhelming lawsuit numbers are widespread. Creative lawyers have expanded the liability theory to include "what you could or should have done to foresee the damage that occurred to my client."

In a July 2012 Professional Roofing article titled "What's that smell?," the author, David M. Gersh, an attorney with Atlanta-based law firm Hendrick, Phillips, Salzman & Flatt, describes two distinct situations that keep many business owners awake at night. Two cases discussed involved roofing companies that were sued because of what appeared to be inadvertent chemical exposure by end users of buildings where roofing services were provided.

In the first scenario, teachers in a school were exposed to fumes related to the application of spray polyurethane foam used to reroof the school. In the second case, a group of air traffic controllers were exposed to fumes from an adhesive that leaked into the building. In both instances, the contractors seemed to have taken the necessary precautions to complete the project with due professional care.

However, the courts disagreed and granted the plaintiffs seven-figure judgments to cover current damages suffered; the judgments also provided for potential future illnesses related to the roofing materials exposure. In these cases, the liability theory was used and deemed to be the primary cause for the judgments against the contractors.

With legal representation rates varying from $50 to $1,000 or more per hour, the liability theory provides a business incentive for litigators to seek creative ways to promote litigation. Television and other media litigator ads are a testament to this incentive. Contingency-compensated litigators typically receive one-third of the eventual settlement or award in a case without asking for a fee upfront; a "sue now, pay later" attitude is common. This joint-venture approach to litigation sometimes can help a plaintiff with limited funds who otherwise would not have access to competent counsel. Often, the joint-venture approach facilitates litigation that may not have been undertaken by those with adequate funds to traditionally engage counsel.

The key point is few contingency litigators agree to take on a case with such a payment arrangement unless they are certain there are "deep pockets" that can somehow be tied to the damages being sought. This is where perceived affluence is a potential target for litigation even if only remotely connected.

You're a target

For roofing contractors, lawsuits can stem from numerous business activities, including real estate, employees, products and vehicles. It is important to understand lawsuits undergo an economic analysis before a case begins—how much cost, time and effort will need to be invested, chances of winning the case and what assets are available to pay a judgment.

Let's take a look at a relatable example: You're driving your car when suddenly you are hit from behind; the driver who hit you is unemployed and has allowed his car insurance to lapse. No lawsuit is needed, regardless of fault, because there is nothing to gain. Now, if we substitute the driver of the car who hit you for an employed professional who is driving a new BMW, has insurance and lives in a large estate, the case complexion changes despite the fact all other circumstances are equal. The difference in these two examples is the perception of getting paid. The adage "you can't get blood out of a stone" bears some weight here.

As a potential defendant in a civil case, it is important to understand the process a plaintiff's attorney will undergo. An attorney considering a contingency case focuses on economics to determine the cases that make the most sense to pursue. If there are no assets to gain, there is a slim likelihood the plaintiff and attorney will get paid even if the case wins.

Gersh presents some practical and prudent steps you should take to mitigate your exposure to such lawsuits. These actions should be the foundation of running any business. Unfortunately, though many business owners conduct their businesses in such a manner, accidents do occur. When these accidents happen, how will you be protected?

Insurance is not enough

Many who are confronted by litigation are quick to turn to their commercial general liability (CGL) and property casualty insurance policies. However, there may be exceptions to policy coverage. Furthermore, with the substantial awards that are being doled out by juries, the policy coverage may not be enough to pay the judgment.

The judgments awarded to the plaintiffs in the two cases noted were substantial and could easily put the companies out of business. However, as large as the awards were, juries seem to be handing out even larger awards to plaintiffs. Following are just a few recent cases and the judgments that were delivered by juries:

  • May 2012—Portland, Ore.: A jury awards $332,000 to two men who were fired after they complained to the Occupational Safety and Health Administration about the lack of a toilet on the job. Although this judgment was not as significant as others, the amount awarded compared with the action may seem somewhat excessive.
  • May 2012—Corpus Christi, Texas: A jury awarded $24 million to a woman struck by a cola delivery truck when the driver was talking on his cell phone. The jury awarded $10 million in punitive damages and $14 million in actual damages. Punitive damages are explicitly excluded from CGL coverages.
  • 2011—Polk County, Fla: A jury awarded $65 million to the driver of a car that was broadsided by an 18-wheeler truck, leaving the 19-year-old driver of the car with brain damage.
  • March 2012—Sacramento, Calif: A former hospital employee claimed she was subjected to filthy conversations among physicians and staff about their sex lives, unwanted sexual advances and demeaning comments, and frequent comments alluding to her heritage. After 11 days of trial, the jury deliberated two days before returning a guilty verdict and awarding the plaintiff a $167 million judgment.

In each of these cases, roofing workers and/or roofing equipment or vehicles could easily be substituted as the causes of injuries. Because of the sizes of these awards, it begs the questions: Who carries $167 million of liability insurance? And who would sell you that much insurance?

Protecting your assets

The best protection method is, of course, not to be sued. Therefore, making yourself unattractive to lawsuits should be a priority. This can be accomplished by implementing asset insulation strategies to your business and personal life. At the asset insulation core is positioning assets and finances in such a way that it is difficult for a creditor to reach them, making litigation a distant chance.

Common techniques to reduce risks such as liability insurance and risk mitigation should be employed. However, the chances of considering all possible contingencies, covering all risks with insurance and taking all precautions are remote. Regardless of how well you execute a roofing project, there always is a chance for a plaintiff to sue. If a case goes to court, irrespective of a successful defense, the defendant already has lost because of the time, legal cost and distraction from business activities. Therefore, you must go beyond reducing risk and insulate your assets to reduce the incentive to sue you. In the event a lawsuit does occur, asset insulation will limit or eliminate a plaintiff's ability to reach your assets.

Asset protection is not a specific technique or product but rather the purposeful structuring of assets to limit liability exposure, making assets difficult to attach and segregating risk. There are some common misconceptions regarding C and S corporation liability protection. As a matter of law, assets inside a C or S corporation can be acquired by a plaintiff. Furthermore, if a plaintiff's attorney is able to find sufficient evidence, assets outside the corporation also may be acquired. This group of assets generally would include personal assets.

Many times, techniques are used in combination to enhance protection and benefits. A creditor may place a lien on assets owned personally, jointly, by partnership or by a corporation, etc., but the statutes governing preferred entities preclude a lien on entity assets for claims against the owner. Achieving asset protection usually involves using entities that have insulated characteristics, such as limited liability companies, limited partnerships and some trusts that provide formidable impediments to acquisition. Because a plaintiff cannot access the assets, there is a good possibility litigation can be discouraged from the onset.

If properly implemented, asset insulation can provide you with an additional layer of protection beyond your existing liability coverage. Asset insulation:

  • Renders a potential defendant unattractive to litigation by removing the financial gain incentive
  • Insulates major assets from creditors and predators
  • Promotes settlement, thereby leveling the playing field
  • Integrates with estate planning and tax minimization objectives without gifting assets or losing control of those assets

Protection against liability exposure can be further enhanced by separating the distinct assets category to segregate the risk among those assets. Risk segregation involves separating categories of assets, such as equipment, vehicles, employees and real estate, that may generate a liability into separate "containers." This will prevent one asset category from being targeted because of the litigation that occurred by another asset category, thereby resulting in minimal organization disruption.

It should be noted some assets are not suitable for entity ownership and, therefore, asset insulation. This often includes personal residences, properties with existing mortgages, receivables, etc. If you use an engineered loan against an asset, the asset's equity can be reduced to such a low level that it would be unattractive to a creditor; this is referred to as "equity stripping." In a foreclosure, even if a creditor pursues a claim, the debt to the first lien holder would be paid first and the equity would be separated from a creditor.

The most effective planning involves integration of overlapping areas that affect a family's net worth, including:

  • Asset protection (insulating against claims from any source)
  • Estate planning (incapacity, death disposition, probate reduction, reduction of death taxes, guardianship, managing inheritances)
  • Tax planning (leverage, income tax shifting, maximum use of transfer credits, coordination of federal and state death taxes)
  • Business planning (exit strategy, key person retention, company structure, perpetuation)
  • Insurances (shifting risk, funding tax burdens)
  • Asset titling
  • Entity structure

Be safe, not sorry

Although most business owners operate their businesses in a manner that promotes professionalism, quality and safety, accidents do occur. And though many of these same owners have taken what may appear to be appropriate steps toward managing risk against lawsuits, they are operating without a safety net. Many owners don't realize it is possible to have a legal judgment assessed against them for an event they did not participate in or of which they were unaware. If you lost everything, where would you be?

Asset insulation strategies play a significant role when managing business owners' and affluent individuals' risks by protecting their assets from creditors and predatory lawsuits. For many, these strategies are as important as estate or financial planning. What purposeful good does a solid financial plan accomplish if those assets could be subject to involuntary wealth redistribution?

What should you do?

A lawyer who is experienced and fully understands the complexities of asset insulation can provide you with the education and advice necessary to properly insulate your assets from unnecessary claims. Creating an LLC is not enough. Legal documents must be drafted in a manner that will include the appropriate language and structure to offer the protection sought.

In addition, a policy review from a qualified property and casualty agent should be conducted to address the limits of your CGL policy, including any exclusions of which you need to be aware. After you have educated yourself about the potential pitfalls and areas of exposure, a comprehensive risk management strategy should be employed. The risk management approach should focus on insulating personal and business assets, which many times can be coordinated with estate planning needs, as necessary.

The key points and benefits to remember about asset insulation are that, if properly implemented, they can provide business owners and affluent individuals with an additional layer of protection against creditors and predators beyond their existing liability coverage.

Joseph Bazzano, CPA, CVA, CBEC, is chief operating officer of Beacon Exit Planning LLC, Hartford, Conn.



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