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Business Protection

Business Protection

The first consideration in structuring a sound asset protection plan is deciding which form of entity should be used to operate your business. The possible choices include general and limited partnership, sole proprietorships, trusts, limited liability companies, and corporations. Each has different legal characteristics, tax attributes, and asset protection features. The right combination is based upon the nature of your business, whether you will have outside investors, the degree of liability protection needed, and which entity creates the greatest tax benefits. Many physicians use a Professional Corporation (PC)—an entity with special features, determined by the state where the practice is conducted. In this chapter, we will examine the advantages and disadvantages of a corporation and see how it fits in with the overall plan we will develop.

Corporations are a form of business organization permitted by law in every state. A unique feature of a corporation is that it issues shares of stock. A share of stock entitles a shareholder to vote on the election of a board of directors, which is charged with the overall management of the corporation. The board of directors elects the officers—the president, secretary, and treasurer, who are authorized to conduct the day to day business of the corporation. Many states permit a single individual to serve as sole director and to hold all of the corporate offices. One of the unique features of a corporation is that it is intended to have a perpetual existence. The death of an individual director or officer does not terminate the existence of the corporation. Instead, the corporation carries on indefinitely until it is dissolved by a vote of the shareholders.

A corporation is legally formed and begins its existence upon the filing of Articles of Incorporation with the Secretary of State of the state of incorporation. You can choose to incorporate in any state you wish. It is not necessary to incorporate in the state where your business is located. A disproportionately large number of corporations are formed in Delaware. Most large public companies are incorporated there. Delaware has encouraged corporate formations by adopting laws that favor incumbent officers and directors against attack from dissident shareholders, has a long history of decided court cases interpreting its corporate law, and has no state income tax. These are attractive features to consider when choosing a state for incorporating. Nevada is another state without corporate income tax, and its laws are also designed to actively encourage new corporations.

Limiting Personal Liability
The primary distinguishing feature of a corporation is the so-called limited liability of the officers, directors, and shareholders (the “principals”) of the company. In a properly organized, maintained, and capitalized corporation, the principals have no personal liability for debts of the corporation. If a corporation breaches an obligation or causes injury to a third party, only the corporation and not the principals are legally responsible. If the corporation does not have sufficient assets to satisfy the liability, the creditor is not entitled to seek satisfaction from the personal assets of the principals. This feature is distinct from other businesses operated as sole proprietorships, partnerships, or trusts. In those cases, the owner, partner, or trustee, respectively, has unlimited liability for debts incurred in the business.

Professional Corporations
The problem for physicians is that personal liability for malpractice cannot be limited by using a corporation. Regardless of whether you conduct your practice through a PC, you will not be shielded from any claims asserted for injury to a patient. If you lose a case, any amount not covered by your insurance will be satisfied from your personal assets. With jury awards of $3 million and up occurring with some regularity—your entire net worth is on the line with every patient you treat. We will see that if you cannot legally shield yourself from liability—the proper strategy is to protect what you own from a potential claim.

Although the PC won’t protect you from claims by a patient which you treat, it can be used to defend against the negligence of a partner. If your practice is organized as a general partnership, you are legally responsible for any injury caused by your partner. Even if you don’t do anything wrong, you are liable for the actions of your partner. But using a PC limits your responsibility to only those acts committed by you or your employees. You are not liable for injury caused by a “partner” in your medical practice. For those in practice with other doctors, the PC creates a necessary degree of liability protection.

Effect of Personal Guarantees
Anyone doing business with a corporation may require that the principal of the company give a personal guarantee of a corporate obligation. In simple terms, the person signing a guarantee promises to pay the corporation’s debts if the corporation is unable to do so. For example, if you wish to lease office or retail space for the business, the landlord may request a personal guarantee of the lease obligation. If the corporation fails to make its payments on time, the landlord can then collect directly from you. In this manner, a personal guarantee eliminates the benefits of the corporation’s limited liability.

Similarly, vendors sometimes will not sell, and banks and other lenders often will not lend to a family corporation without a personal guarantee. To the extent that guarantees are provided, an individual owner will have personal liability for these contracts, and the corporation will not provide protection from these obligations.

Protection from Tort Claims
Except for professional malpractice cases, when the source of the lawsuit is a negligence claim or a claim arising out of the employer-employee relationship, the corporation can be an effective device. We have previously discussed how an employee’s negligence may be imputed to his employer. If your secretary injures someone while she is picking up your lunch, you are likely to be responsible for the damages. However, if the secretary is an employee of a corporation, the corporation, but not the officers or directors, will be liable for the injury. This is also the case generally for employee claims of discrimination or wrongful termination. Any such lawsuits will be filed against the corporation as the employer. The principals of the company will not usually be held personally liable for these types of activities.

Protection from Customers
When the corporation sells goods or services (other than professional services), liability for these activities will usually be limited to the corporation. A buyer of goods (as opposed to a seller) typically does not require a personal guarantee as to the quality of the product. If the product is faulty or someone is injured by the product, the corporation will be liable but not the principals. If a corporation supplies services, such as contracting or repair work on a house, only the corporation would be liable for faulty services. A corporation provides a useful shield against personal liability in connection with the sale of products or services. When a corporation buys goods or services, liability for payment will also be limited to the corporation, unless the principals have signed a personal guarantee of the obligation.

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