Corporate Asset Protection

Don’t Put All Your Eggs In One Basket

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By William J. Strons

Many closely held corporations start off as small enterprises that lease space and equipment from third parties. As the corporation grows, it often starts purchasing its own equipment and eventually it looks to acquire its own facility. But, is it a good idea for a corporation to own its own facility? The answer, from an asset protection standpoint, is almost always “no.”

It is true that shareholders of corporation’s enjoy “limited liability.” This means that the creditors of the corporation cannot typically pursue the corporation’s shareholders individually in order to satisfy the debts of the corporation. Therefore, a shareholder’s personal assets (including their home) are generally safe from a corporation’s creditors. Keep in mind, however, that a failure to follow corporation formalities, making fraudulent transfers, or executing personal guarantees can cause a shareholder’s assets to be available to corporate creditors.

Still, for many business owners, the reasons for owning a facility are plenty, and include saving on rental payments, exercising greater control over the facility, and enjoying the investment opportunity of real estate. But, these can be accomplished with the added benefit of some asset protection, by purchasing the facility with another entity (preferably, a limited liability company).

How does this work? Well, let’s assume for a moment that the shareholders of a closely held corporation have identified an attractive facility to operate their business. If the corporation buys the facility, then the facility will be subject to the claims of the corporation’s creditors. Remember, all of the corporation’s assets are available to the corporation’s creditors but some creditors (like secured creditors) have a priority over other creditors with respect to certain assets (e.g. a bank holding a mortgage).

If, instead, the shareholders formed a new entity to purchase the facility, they could then lease the facility (for fair market value) to the corporation. This structure protects the facility from the creditors of the corporation. It will not protect the facility from the creditors of the newly formed entity (e.g. the bank holding a mortgage on the property).

In addition to dividing risk between the operating company and the newly formed rental real estate entity, this structure allows a shareholder to sell the corporation and retain the facility. If structured correctly, the new owner of the corporation will pay rent to the real estate entity and provide continuing cash flow to the former shareholders in the form of lease payments.

As with any planning technique, this ownership structure does not work for every client. It is, however, common place in current corporate planning. Some corporations actually have three separate entities, one that owns the operations, one that owns the equipment (leased to the operating company), and one that owns the facility (again, leased to the operating company). Before buying any real estate or substantial equipment, you should consult with your attorney.

For those corporations already owning their facilities, there is planning you can do to separate the business and the real estate. You should discuss these concepts with your attorney and tax professional before transferring any assets, and remember, when corporate planning, don’t put all of your eggs in one basket!