Ep. 62 | Don’t Ruin Your LLC Protection – How To Avoid Piercing The Corporate Veil

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On this episode of The Mobile Home Park Lawyer, Ferd discusses protecting yourself through a limited liability company and provides you with some guidelines on how not pierce the corporate veil. Enjoy!

 

HIGHLIGHTS:

0:00 – Intro
0:50 – You cannot ever own property in your personal name
1:32 – You have to have an LLC
2:35 – You need an operating agreement
4:11 – Ferd speaks about piercing the cooperate veil and how to avoid doing it
8:11 – Ferd advises you to avoid co-mingling and follow formalities
9:33 – Make sure you have arm’s length transitions
9:55 – Make sure you maintain the appropriate capital levels
11:10 – You need to have insurance

 

FULL TRANSCRIPTION:

Welcome back mobile home park nation. Today. I’m going to dive into something that honestly, I didn’t think I needed to cover, but it’s come up recently with a few clients and prospective clients. So I thought I’d cover it. And it’s what I call the common sense of running a business, and that is protecting yourself through a limited liability company. And I try to skip over the mundane and kind of 101 stuff here on the podcast to try to go more 201, 301 frankly, because that other stuff bores me. But today I’m going to cover kind of a hybrid.

So, readers digest version, you cannot ever own property in your personal name. That is just craziness. For a number of reasons, the chief reason being you have massive liability exposure. If I own a mobile home park in my name and something bad happens, my maintenance guy, you know, cuts his arm off. My mowing guy runs over the paperboy, a pit bull eats the neighbor kid, something horrible like that. Not only am I going to get sued and lose my trailer park, I’m going to lose my house. I am going to lose my car, I’m going to lose my checking account, etc. And I can have some protection with insurance, and you should have umbrella insurance even in addition to general liability insurance, work comp insurance, etc., but you have to have an LLC and there’s other corporate structures, C Corp, S Corp, LLP. You know, all those have their own pros and cons. I think the common wisdom today is you get an LLC, which is typically taxed as a partnership, which means it flows through. It’s not a benefit. It’s not double-taxed like a C Corp. Then at the same sort of restrictions as an S-corp, LLP, I don’t really know the fruits of the LLP. I don’t really see why you do an LLP other than LLC, unless there’s some state-specific rule, such as California. A lot of the law firms are LLPs instead of LLC. There must be some prevailing wisdom there that I’m ignorant of.

But overall, just go with the LLC and we set these things up for you all the time and setting up the LLC is pretty simple. And my assistant does the first portion, which is you got to get an EIN from the IRS. You got to get articles organization from the state. And there’s a small fee to that anywhere from 50 to a couple hundred bucks, depending on the state, you have to have a registered agent, typically as a human who lives in the state that you incorporate, and then you need an operating agreement. If you’re a single party, it doesn’t matter if I’m on the internet. If you’ve got two or more people, you probably need to have a lawyer drafted. And you need understand what’s in there because it impacts your rights.

If you’re doing a syndication, you also need to private placement memorandum, and I’ve, I’ve covered that at nauseum in other podcasts. So that’s the one-on-one. I’m not going to dive into all the pros and cons of those. I think everybody gets that stuff at this point in the game. So here’s why I’m bringing this up today. A new client, he just sold property that he owned in his personal name, and he wants to do a 1031 exchange. Well, when you buy the replacement property at 1031 exchange, you must acquire a title to the said replacement property in the same name as the previous property. Well, the previous property was John Smith. Well, that means you got to buy the next property in John Smith in order to avoid the capital gains. And he also wants to partner to a joint venture or a syndication on replacement property. Well, it’s pretty hard to sell a minority interest or a majority interest in John Smith, as opposed to John Smith, LLC. Number one. So he’s got a practical problem at this point, even though he’s skated free, you know, and didn’t, you know, get eaten by the paperboy or, you know, run over by, you know, the paperboy or something like that, whatever the hell that saying goes. So he’s kind of screwed the pooch already.

So, don’t do that one, but two here’s something people mess up all the time and it’s called piercing the corporate veil and they teach this stuff in business school. So I think there’s a lot more people out there that went to business school than law school. So I thought there’d be more people that recognize it. And I’m sure there are, I don’t mean to be offensive with that. I mean, I’m here to educate, but it just blows my mind when people are, you know, buying their personal TV through their LLC. Oh cool, I get a tax write off because it’s business money or they’re taking a vacation oh, my wife and I went to, my wife and I just got back from Key West. I didn’t use my business credit card for anything. A lot of people who are super aggressive, oh no, no, no, we were looking at property. We were thinking about buying an investment property in key West. So that was, these meals, these are all deductible. This flight was all deductible. Oh yeah, My wife, she’s my assistant. That’s pretty aggressive if you ever get audited by that arrest, but it also might pierce the corporate veil. And what does that mean?

It means basically you blow through you pierce through this, this veil of limited liability, which is the key fruit of the LLC. So don’t do that. And how do you not do that? You act like you’re a real company. And my dad and I started in 2008, March 2008 in the real estate business. And I said, dad, at that time, I wasn’t an attorney at that time, but I said, dad, we’re going to set this thing up like, we’re a big company in case one day we are a big company, and we bought a single rental house next to rockers university. And I think I had $14,000 pulled together. But we set it up and ran like a big company. So what does that mean? How did we not Pierce the corporate veil? Well, we do things like have appearances that matter. Like we have business cards, we had a website. At that time we didn’t have the email. We still had an @yahoo.com which I think is a little junior varsity. But we had, at least it was at Third IV Properties. So you know that appearance helps, but you should have, you know, corporate formality is another one. I mean like appearances, but then also the formality of like, we typically do it on New Year’s Day. We have a board meeting, Hey Ferd and Ferd what do you guys want to do today? Let’s vote. And we didn’t have, and you don’t, you can make that as simple. And we keep minutes, and we sign them, and we record, we file these. I got them in Google drive just a bunch of minutes and I got that for a bunch of LLCs and it just says, it can be as simple as who was present? Members Ferd and Ferd, what did they decide? They decided that all preceding actions for the year prior, or hereby ratified and approved that they were all valid and according to the goals and bylaws and Ferd and Ferd hereby, you know, deputized to make similar and frankly, any and all decisions in the forthcoming year.

It sounds ridiculous. But look, that’s what a real company would do. They have minutes, the have board meetings. And another thing that real company would do is they would, they would not co-mingle. So like I have my cell phone for example, is paid out of an LLC account. You know, my home internet subscription is not because my wife uses it, and my kids use it. It’s not just business. My work internet connection at my office is a business expense. I don’t [07:21 inaudible]. Do I own shovels and drills and wheelbarrows and snowblowers in the business account? Yeah, I do because they use for my business. My truck is owned by my business. My wife’s van is not, so don’t co-mingle, don’t buy stuff for your personal name and then, you know, Oh, it’s kind of messy to keep getting reimbursed. Don’t just pay for meals. You know, certainly don’t buy things like groceries. Now I pay for the occasional meal. Like if we got a big Workday, I buy pizza for the whole crew, but that’s clearly for the crew. Now, am I eating some of that pizza?

Yeah. But it’s part of the work. So that’s a diminimous use of you know, for my benefit, diminimous benefit for me getting couple slices of pie. So ultimately appearances matter, avoid co-mingling and then just follow formalities. Make sure your paperwork is set up properly. Make sure you have the right documentation to state, the right name on the LLC, checking account. You file a separate tax return, which if you have a single member LLC, it’s called a disregarded entity, and it just flows up to your personal. If you have to two or more members, you have to file a form 1040, which is a partnership return in federally and in the state of where the activity is, which is where the money is made, which is where the property’s at. And then every investor gets what’s called a K1.

So that kind of stuff is, you know, basically it’s called good corporate governance, rules, procedures, even beyond the law. You know, I have tenant screening procedures, written procedures of how we approve people. We have things like checklists for staff. We have employment contracts with our property managers. We have waivers of liability for our vendors. We log, you know, insurance on our own casualty insurance on our own mobile homes and in real estate, but we have worker’s comp insurance. We require insurance from vendors, or they be covered by our worker’s comp insurance, etc. Those are the kinds of things that a company does to watch its back.

So in addition to those things having ancillary or perhaps primary benefits of liability protection, it helps protect the piercing the corporate veil, which is a doomsday scenario. Another thing is to make sure you have arm’s length transactions. I don’t think this is to be that big a problem. Like I’m not going to push my own snow. I don’t know how to slow plow on a truck. So I’m not hiring my brother, you know, for, you know, an inflated price. And then stiffen my investors. So just make sure you do that as well. And then another one that people sometimes Jack up is they don’t maintain the appropriate capital levels. And this is one that I, you know, I probably am more aggressive at, from a cash capital, meaning I don’t want to keep a hundred thousand dollars in my trailer park checking account. I want to keep as little as reasonable, you know, when that’s probably at least one month’s revenue. So if I make this, if this property has $20,000 a month revenue, I should probably have at least $20,000 reserves there at all times.

But if that property gets sued, you know, cause you know, the lawnmowing guy shoots a rock and hit some kid in the head, that kid’s parents are going to sue me for more than $20,000. So I would have essentially neutered their right to receive benefit in a judgment because I’ve diluted that account down to $20,000. So 20,000 is probably reasonable enough, but if I had only kept like 50 bucks in there and just constantly kept bleeding it out so that it was, you know, making owner distributions to me. So I don’t have to have as much exposure, that would probably look like I’m purposely not maintaining appropriate capital levels.

Now here’s the savings to that, insurance. So cases have decided you know, many a time that if I only got 50 bucks in the account, but I have a million-dollar liability policy. Okay. I’m properly capitalized because there is remedy or essentially there’s some pot of gold at the end of the rainbow for that kid’s parents to go sue me. So a lot of, you could make up for a lot of sins of the past if you got a lot of liability insurance coverage. But that’s one people don’t, they don’t have proper insurance and they constantly, you know, bleed the account. You’re really risking that provision of what’s basically called maintaining appropriate capital and having enough money in the account.

So those are the five or six, I wasn’t really counting five or six reasons and procedures, if you will, that can protect you from piercing. The corporate veil can’t emphasize enough how important it is and can’t emphasize enough to never own property in your personal name, you know, your personal residence. I don’t care that much if you have your personal residence in your name, but investment property, a mobile home park, holy cow. So anyway, until next time have fun, stay safe, follow the law. And don’t pierce that corporate veil. Thanks.

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