There is always much debate on if an LLC is needed. I have one. Only because someone told me to hold my properties in it for protection. I paid a lawyer to draft it and I signed it, and filed it away. I read most of it, but I honestly couldn't tell you if it was even worth the paper it was written on. If I was sued, I wonder if I would actually be protected.
I'd love to hear from people who had an LLC that actually protected them from being sued and found liable for something.
This is a great question, though I suspect responses will be limited only because it's probably not that common. I'll go ahead and throw out an example of a lawsuit my firm was involved in a couple of years ago, in which I would say the LLC worked as it was supposed to. (I had no personal involvement with the case.) It was a larger apartment complex with separate management. A little girl was run over and killed in the parking lot by an employee of the manager, and the entity that owned the apartment, the entity that managed the property, the manager, the driver/employee were sued. I think the theory was there should have been children playing/ speed limit signs and speed bumps. Long story short, there was a $1M verdict against the defendants, all of which was covered by insurance.
I would say the LLC worked because there was zero consideration given to suing the passive owners of the property who had nothing to do with the management or operation of the property. It would have been a waste of time, and I think that most plaintiff's lawyers would have reached the same conclusion. Also, there was insurance, so there wasn't that much incentive to go through the quixotic attempt to pierce the veil. (This was a professional operation and not some mom-and-pop single member LLC, so they had probably done everything right.)
I would also say that the case illustrates why smaller investors who manage their own properties or are otherwise actively involved should not over-rely on LLCs. Everyone who had any active role with regard to the property got sued, and I believe there was liability placed on everyone. I would also say that the case illustrates the importance of liability insurance. At the end of the day, everything was covered by insurance, and the LLC ended up being superfluous.
This is a great question, though I suspect responses will be limited only because it's probably not that common. I'll go ahead and throw out an example of a lawsuit my firm was involved in a couple of years ago, in which I would say the LLC worked as it was supposed to. (I had no personal involvement with the case.) It was a larger apartment complex with separate management. A little girl was run over and killed in the parking lot by an employee of the manager, and the entity that owned the apartment, the entity that managed the property, the manager, the driver/employee were sued. I think the theory was there should have been children playing/ speed limit signs and speed bumps. Long story short, there was a $1M verdict against the defendants, all of which was covered by insurance.
I would say the LLC worked because there was zero consideration given to suing the passive owners of the property who had nothing to do with the management or operation of the property. It would have been a waste of time, and I think that most plaintiff's lawyers would have reached the same conclusion. Also, there was insurance, so there wasn't that much incentive to go through the quixotic attempt to pierce the veil. (This was a professional operation and not some mom-and-pop single member LLC, so they had probably done everything right.)
I would also say that the case illustrates why smaller investors who manage their own properties or are otherwise actively involved should not over-rely on LLCs. Everyone who had any active role with regard to the property got sued, and I believe there was liability placed on everyone. I would also say that the case illustrates the importance of liability insurance. At the end of the day, everything was covered by insurance, and the LLC ended up being superfluous.
Great post John! Hope you'll monitor this thread @John Chapman
We may get more posts as I'm sure .many operators stick the LLC documents in a drawer and forget about them.
You LLC doesn't need to be read, it needs to be studied carefully.
It also needs to be tended to, there are entity maintenance matters to oversee depending on how it is structured you may need to keep your LLC tuned up monthly but at least annually for it to perform.
Your company may need to authorize the purchase and sale of real property. A closing agent will want to see the authorization with the manager or appointed member having the authority to act on behalf of the business.
BTW, speaking of authorizations, I have seen where investors are taking the LLC docs to settlement along with the Operating Agreement. I would never put all of my Operating Agreement out there to be filed away in RE settlement files. They only need that part that addresses the authority to act, not the entire agreement.
Hopefully John might comment on the most popular approaches taken to pierce the corporate veil. Especially for active members of single member or family member entities and the back door issues of the company being an asset owned by these individuals.
The very best way to limit your liability is through good management, operational practices and keeping properties in good, safe conditions. Good management should have foreseen, in a larger project the need for the "Slow Children At Play" and speed bumps. (I get a kick out of the slow kids signs, makes them sound retarded) :)
The next defense is with having sufficient insurance. I'm surprised that large project had only a million, and not say 5 million, I suggest a million for a SFD. It use to be a million covered most death claims, John or your agent may have better insight to that today. I'll just say mine is sufficient.
You know, there were landlords before LLCs were even thought of. :)
@Bill Gulley thank you for the compliment. Here some additional thoughts.
First, I totally agree that the apartment complex should have had more insurance. Liability was actually very hard to show in this case, which is the reason I think the verdict was rather low. (I think the jury just split the baby, felt there were huge damages but difficult liability) It easily could have turned into a multi-million dollar verdict with another bad fact or two. Also, this was only a single death (and I don't say that to be cavalier) but if there had been multiple deaths, which does not seem inconceivable in large apartment complexes with people living in close proximity, then the number could have been much larger. $5M probably would be better in terms of coverage.
Second, in terms of piercing the veil, it varies state by state, but some common factors are failing to adequately capitalize the LLC, commingling personal and LLC assets, failing to follow corporate formalities, etc. Often times a jurisdiction will also require that there be some sort of fraud/unfairness that would occur if the veil is not pierced as well. Again, it does vary by jurisdiction.
Third, I agree that there's no need to bring the operating agreement to settlement. That's generally a private document. Only person who should probably get that is your lender.
Thanks @John Chapman
As I suspected, the "shell" entity that is under capitalized and serves little toward any business purpose. The concept of the "Parent Holding Company" or a "Management Company" that is basically idle, has enough funds to keep a checking account active with the obvious intent of simply being a firewall.
Commingling funds is a common mistake. Writing checks for the exact amount is important, writing a check at a grocery store for ten bucks over the receipt is an issue, where the cash goes in your pocket, besides the issue of showing the business purpose of things purchased at a grocery store.
I know of one LLC that failed meet the test since the minutes of meetings were never kept or any record of meetings authorizing activities.
I would think that any attorney drafting an LLC for a client would run over the these issues with their client. It's the ones who get those internet forms and try to do things themselves who will miss these types of issues, making it all for nothing. :)
The only test we have been subjected to is the buyers attorney & the Title Co perusing all the LLC documents if & when the Title of the property being sold is held in the LLC.
We have also had to supply copies of same to the City Attorney on a couple of Tax Lien Auctions we won the bids on ???
Representation in Housing Court can be by the LLC manager of record for the proverbial 'code violation' tax grab.
More than adequate liability insurance is the 'advised' norm but the latter will not cover illegal action, the pursuit of voracious creditors or the many exclusions including ingesting Lead paint.
We also record & file weekly minutes, as well as all resolutions regarding any new acquisition/dispositions etc
@John Chapman Very interesting case that you posted! A couple questions:
Did the one million paid by the insurance company cover everyone, or was the driver personally held responsible for some type of payment?
If there had been no LLC's at all, would the case have been any different, or would the same one million have been paid by the insurance and case closed?
Joe Gore
@Bryan H. made a statement at the end of his post that wasn't directly answered. The point of an LLC is not to prevent you from getting sued. It is to protect your personal assets if you do get sued. In the example above, insurance covered the suit, but let's say the plaintiffs were awarded a $20M judgement. In that case, insurance would have maxed out and the entity would have gone bankrupt, but if the LLC members had millions of dollars in their personal bank accounts that money would be protected IF they had correctly maintained their entity. That's the whole point of the LLC. Commingling funds and record keeping are the two biggest issue that can pierce the corporate veil, so if you are going to go to the trouble of setting up and LLC, then make sure to properly maintain that arms length relationship.
BTW, I also recognize that you could be personally sued in my example, but a correctly structured entity exists solely for that reason and the hope is that you would easily win such a suit.
I now feel compelled to say that I'm not a lawyer and this post does not constitute legal advice....
I spoke with a lawyer a few weeks ago and instead of an LLC, she suggested setting up a Limited Partnership where I would be a LP and the General Partner would be an S corp that I am Director of. Is this any different or any better than just doing an LLC?
@Rob K. My memory is a little fuzzy, but I believe the driver was held personally responsible for a small percentage of the accident and it was not covered by the insurance of the entity. However, that didn't matter because the jury allocated enough responsibility that the entity was jointly and severally liable for the entire judgment (was responsible for the entire judgment). As an aside, any judgment against the driver was worthless, so the goal at trial was to downplay the driver's responsibility and put as much on the entity.
I don't think the fact that there was an LLC would have changed anything. My recollection is that there were virtually no settlement offers before trial,so the case had to go to verdict. It was an exceptionally difficult case because the driver was going really slow and the kid had darted out. I think a different jury could have easily gone the other way.
In terms of prosecuting the case,I think it would have only made a difference if the case had been stronger from a liability standpoint such that the conversation before trial would have been how many millions had to be paid. Then, if there wasn't an LLC, we'd be looking at the assets of the individuals in order for them to kick in above and beyond insurance.
Bob, I just see that going upstream as the GP is liable that goes to the S-Corp that has a longer judicial history than an LLC.
@John Chapman hate to impose, but this is down your alley. I don't see much difference between the director or the managing member. Edited, You posted before me.
Funny too that investors get a million on the liability and then get 10/50/100 on their auto policy. The flipper pulls his trailer to a job site, it breaks lose and kills a Nunn and six kids in a crosswalk. Loosing through the backdoor.
Wade, devising the amount of coverage takes in several aspects of risk assessment. Your jurisdiction, the political flavor and social aspects that may influence a jury, past cases, types of exposures related to the business activity and ability of management. No multi-millionaire I know holds high dollar amounts in personal accounts or holds other assets individually, use irrevocable trusts or other trust arrangements.
If you are really going to get hammered with a large suit and you are under insured, it could well be that your insurance company throws up a white flag, writes a check to the limits of liability and walks away leaving you at the alter praying on your knees by yourself to the judge. Just saying, the insurance company has no obligation to bring their attorney in, they aren't saving your tail as much as they are theirs, up to the insured limits. If they see they are going to lose the whole bag of marbles they could just hand them over and not even show up to play.
So, make sure your coverage is "sufficient". :)
I'd think really long and hard about forming LLC's. They are a major pain in the *** to function under, obtain financing with, perform accounting, taxes, etc. In my case my profile is rather low: I own small properties (no parking lots!), they are well maintained, and my tenants are all professions and responsible.
Most liability issues stem from autos and slip/falls on the property. So I have a good umbrella policy that covers my net worth. And I make sure the common areas are in good condition. I think there are some small investors that unnecessarily putz around with LLC's to feel sophisticated about their investments, as it gives them something "important" to do ;)
So I have a good umbrella policy that covers my net worth. ;)
Amit, your insurance should not be set with respect to your net worth, that's irrelevant, unless your net worth exceeds the risks assessed, it needs to be established as to the risks and issues mentioned above.
As mentioned an insurance company can pay and walk away, if your loss is greater than that you're dipping into you money.
Consider too, death cases are based on the loss of income of the injured party, professionals will have a greater value assessed, which means more insurance coverage would be justified.
If your net worth is in 8 figures, you're probably fine, otherwise you may want to review your coverage, liability coverage is cheap. :)
you never really know what the risks are. In the above example someone was killed and all they got was $1 mil. No point assuming you'll get sued, and they will win, for > $10 mil. Not with small rental props, unless you flip out and go mass murder, than yeah, maybe $10 mil will be awarded. Most small prop owners don't even carry $5 mil.
I think this suit is an example of all that is wrong with the legal system. The girls parents, that should have been responsible, did not supervise their daughter and keep her out of the street. She darts out in front of a truck that is being properly operated and the owners of the complex are sued. This whole type of suit should be thrown out with Tort reform, and God willing, the lawyers won't be able to stop it.
^ you don't know that. Maybe the guy drove too fast or wasn't paying attention when driving in the parking lot. If he was negligent, they are very lucky to only have been on the hook for $1 mil IMO. The girl lost her life after all.
John stated that the driver was going really slow and the girl darted out in front of him. It is sad that the girl died but if the same thing had happened on the road next to the complex the city or state would not have been sued. This type of law makes victims out of innocent people so the people that should be accountable, the parents and their lawyers, get to split a million dollars. If you think that is right then no one is responsible for them selves, it is always someone else's job. No one created an intentional hazard to hurt anyone, the law just assumes that if someone is hurt on your property it is your fault. They have no responsibility to exercise the same personal judgement that they would be expected to do if they were on their own property.
So. . . .back to my original question. Is there anyone else out there that was sued and their LLC saved them. Or is the LLC a waste of time & money for smaller investors? Seems like having enough liability insurance would be the prudent thing to do.
Bryan, the only case I am familiar with the LLC did not really come into play either.
A tenant's child had gotten sick. The tenant said in court that she had thought it was because her daughter had drank some laundry detergent. I am not sure if it was found in an examination of the property or the child but the LLC (owner) was found liable from a lead based paint issue. They had to pay a settlement of $10,000. Probably came from insurance but even if not, paying $10,000 with the setup of the LLC was not an issue for this person.
I do not know any other cases personally. I have an LLC for one property and Idon't plan on doing another one until I get significantly larger if ever.
@Bryan H. Here's a thread I started last year that you might find interesting.
I don't know of a case where an entity saved somebody. But consider this probably unanswerable companion question, how many people didn't get sued because they had an entity. A frivolous lawsuit may be avoided when a contingent fee attorney has to go the extra mile to pierce an entity.
I don't know of a case where an entity saved somebody. But consider this probably unanswerable companion question, how many people didn't get sued because they had an entity. A frivolous lawsuit may be avoided when a contingent fee attorney has to go the extra mile to pierce an entity.
That is a very good point.
The good old ambulance chasers aren't usually the cream of the crop attorneys so don't really want to put in a ton of work that they very well won't get paid for.
This is really what I think the biggest benefit to the whole entity and trust structure is making it a PITA to try to sue you.
General thoughts on things are:
1) Nothing is really going to help you much if you actually do something wrong be it malicious intent or gross negligence (This will include insurance)
2) If something bad happens but you didn't really do anything wrong insurance will be the first line of defense always. If you have enough you will probably be okay most of the time. Don't think it can hurt to have an entity set up though and if there was no intent or gross negligence they should have to pierce the veil to get anything past the entities assets if the judgment exceeds insurance coverage.
3) Having the elaborate setups should help avoid the nuisance BS as mentioned above.
So my conclusion are that if you do the right thing and have adequate insurance you will be okay the vast majority of the time. It is a choice as to whether you feel the extra time and expense involved with having some entity setup is worth the other benefits.
Personally I own some stuff in my own name, I run some stuff through a single entity setup, and have some other things in a multi tiered entity setup. I see benefits and issues in all of them.