#630 Think Your LLC Protects You? Think Again

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Transcript

Why LLCs Exist For Protection

SPEAKER_01 0:00

Welcome everyone to the Main Street Business Podcast. This is Matt Sornson, joined by the incredible Mark J. Kohler. Today's topic is about asset protection. Please enjoy.

SPEAKER_00 0:09

The number one reason people set up entities in America is for asset protection. But we're seeing more and more often courts pierce the LLC veil and go after the owners because they're not maintaining the LLC or setting it up properly. This is a big issue. And there's a new case out from New York just in the last year that really exemplifies this problem. And we're going to break it down today.

SPEAKER_01 0:35

Yeah, and actually cleaning up LLCs that people set up by themselves or online is the number one service we did in our law firm last month. We cleaned up more LLCs than we set up new LLCs. And it's because of business owners who want to ensure that their entity is set up properly and they're getting the asset protection, the tax planning, and all the things they've heard about why they should have an LLC. So we're going to break down that case out of New York to make sure you're doing the things properly that they weren't doing and to make sure you're structured best to ensure you have asset protection and that you're minimizing taxes as well.

SPEAKER_00 1:11

Okay,

The New York $10M LLC Case

SPEAKER_00 1:12

the name of this case is Yang versus Knights Genesis Group. And that's Knights like Knights of the Roundtable. And in this case, the defendant, who had two LLCs, and I should say defendants, had set up a couple LLCs and started borrowing money from Yang and others. These are the plaintiffs. They started borrowing money to do some real estate deals. Well, they did not maintain these LLCs, and we're going to go through the particulars, but the loans they took out, at least with this one plaintiff, totaled over 9.5 million. And when it was all said and done in court, the judgment was for over $10 million. And the summary of the judgment was the judge saying, you know what? You guys did not treat this LLC properly. Forget it. It is your alter ego, which means you treated the LLC like yourself. And so I'm going to pierce it. And you personally owe this plaintiff $10 million. The LLC is worthless. And that was the result. Not good. Not good.

SPEAKER_01 2:12

And I think a lot of people are surprised by that, right? Real estate investors use LLCs every day. Mark, you and I use them, right, for our real estate investments, because we're hoping whatever happens on that real estate deal or that business, if something goes bad, that we don't get a judgment against us personally. And I think that is, I mean, that's one reason we sell LLCs and why we like them and use them ourselves and use them for tens of thousands of clients, is that liability protection that the liabilities of the entity don't attach to you personally. And so in that case, like Mark said, just want to make sure I recend the fact. The loans and the documents, the agreement was between Yang and these LLCs. There was no individual that signed for these notes or agreed to pay it back. It was just these LLCs. Well, the real estate deals didn't go well. The LLCs didn't have any assets worth pursuing. So the plaintiff said, I want to go through these LLCs and get to that individual owner. They have other assets. I want to go after those. And so we want to make sure you don't end up like Knight's Genesis group. We don't want your other assets to be exposed. So we want to make sure that you're using the LLC properly so you don't end up like this having your personal assets exposed from a business liability.

SPEAKER_00 3:28

Yeah, we don't want you, no one likes exposure. We want to keep exposed. Not good. Not good.

SPEAKER_01 3:35

They're like, I don't want to be exposed either. What happened to me?

Lending Money Without A Guarantee

SPEAKER_00 3:38

Yeah. Okay. Now we've got to digress for a minute too. I've got to say, Yang, what in the hell were you thinking? If you're going to loan someone $10 million, you loan and get a personal guarantee from the bozos you're loaning to. You just don't loan to an LC. So a note to any of you out there loaning to your brother-in-law or whoever, make sure when you sign these notes, you're getting more of a guarantee than some LLC. And uh be careful lending others if you're just gonna ask an LLC or whatever company to pay back. Okay.

Three Mistakes That Kill Protection

SPEAKER_00 4:12

Now, three things went wrong. And we got to unpack these individually here. Matt, I'll just list these out and you can choose one that you'd like to talk about. The first one was the company, the LLC, did not keep any, uh they didn't keep books at all or records. They had terrible bookkeeping. Number two, they did not observe any corporate formalities. We're gonna explain what that is. And third, they used it like their own piggy bank. They were just like money in, money out, um, there was no accountability. And in the end, the judge said, this looked just like a scheme or a fraud. Like you just use the LLC to take advantage of this plaintiff. But um, those three key points were the building blocks that a lawyer would use to pierce the veil. Because I got to say to the judge, Judge, look, you got you got to be on our side, judge. These guys were ripping people off. And so those building blocks were again, no books and records, no corporate formalities, and lack of any, and lots of combing wing, if you will. Um, Matt, your thoughts.

SPEAKER_01 5:15

Yeah, and I think this kind of where the money's going and use of those funds is is probably an easy one to take off the table because I think if you're operating in good faith and you're doing things legally and as you should, you're you're you're really using those loan funds to put them into that real estate bill you said they were supposed to go to instead of distributing those loan funds and using them for personal expenses or other business expenses, you know, that's gonna cut that's gonna violate that. And that's where the court was like, you know what, you got $9.5 million in loans, and you didn't put $9.5 million into that real estate bill you said that that money was for. You were using it for other expenses and other things, and you took money, those loan funds, out as well. And so I think just know that the the LLC or an entity or corporation is not gonna protect you from misuse of funds. If you're coming into a commercial agreement, whether this is a loan or anything else, you need to use it for what you said you were gonna do. Okay, so I think we can take that off the table because most of us listening, we think most our clients especially are operating in good faith, right? They're not raising money or getting loans like this for improper uses. So if you take that off the table, I think what we see the most and what we're cleaning up is a lot of these formalities and stuff that people forget about in their LLC documents. Like, like they just start with that piece of paper that got approved from the state, and maybe they got a tax ID and they're like, I'm good, I've got it. Well, that's what the court's saying. No, that there's all these other formalities you should be doing. You don't need someone to put a stamp on it, but it's stuff that you have when you have an LLC that you need to make sure you've got.

SPEAKER_00 6:55

Yeah. Now, before we get to formalities, I want to give a little example if that did not land on good faith use of money. There was a day back in my life as a teenager where I was a wheeler and a dealer. I I I was a wheeler and a dealer, and I said, hey, I remember this so well. It was my I said to my mom, hey mom, can I have some money to go buy some new jeans? And I remember the name of the store. This was in eastern Washington. If you're from the Northwest, Northwest, back in the 80s, there was a store called Griggs. That was his name, Griggs, the name of the store. And I remember this vividly. She gives me this money to go buy a pair of jeans, and I had an alternate plan. I was going to misuse these funds, and we had just got a new Nintendo. Now, these are the big old thing in the early mid-80s. And I took that money and went and bought a video game. Okay, did not go well. Um, I she pierced the veil. She said, uh-uh, that was not a gift. You're going to pay me back that money because you went and bought a video game instead of the jeans you were supposed to buy for school. I was like, ugh. And so I was not happy. I had to pay it back. There was a court order, and I was going to be under house arrest until I paid it back. So it was a big gift. So yeah.

SPEAKER_01 8:12

The rule of law at home is the same as the rule of law out in the business world. It's it pretty much works the same.

Operating Agreements And Annual Minutes

SPEAKER_00 8:20

Yeah, very much. Now, these corporate formalities, I I just want to say this, Matt, before I know you've got so much to say on this as well. This is a good thing. People do not look at this as a difficult thing. This is a way to save taxes. Did you just hear that, everybody? I know I got I got your attention, right? If you're on the treadmill or driving down the road, corporate formalities save you taxes because you know why? You're gonna have a board meeting. You're gonna take your loved ones, your family, teenagers, mom, dad, best friends, girlfriends, whatever, and you're gonna go on a little overnighter trip, wherever, whenever, and you're gonna talk about the company and you're gonna document the meeting, and you're gonna have this board meeting that becomes a tax write-off. And oh, wait for it. Take care of some important formalities. This is a beautiful thing doing corporate formalities.

SPEAKER_01 9:12

So here's some of these books and records you should have that they were talking about in the case. When you have an LLC, do you have an operating agreement? Do you have a document that says how the LLC operates? If you just did the minimum articles of organization or certificate of formation with the state, you probably did the bare minimum to state the least amount of stuff that you needed to to get it filed, which is what we do, because that's a public document. But we supplement it to fill in everything else with your operating agreement, including important provisions about how funds are used, um, how you have limited liability protection, how the owners and managers of that LLC are protected from the company's obligations. Like we're preserving these things and stating these things in the operating agreement itself. So making sure you have that operating agreement is critical. And I think a lot of people think, well, if I have partners, I'll do an operating agreement. I don't care if it's just you or just you and a spouse that own that business. The operating agreement is between the company and the owner if there's just one. We want to specify what the business is doing versus what the owner of the business is doing and how those two things operate together. And that's a huge corporate formality that you're not taking care of with just a certificate of formation or articles of organization. And these minutes are important.

SPEAKER_00 10:33

I know some of you have been told or think that, well, because it's not a corporation with bylaws and articles of incorporation, I'm not required to do minutes. Well, you guess what? You're not required to floss your teeth either. But don't you think five out of, you know, four out of five dentists recommend that you floss? Don't you think flossing is a good idea? That's it. Doing minutes is like the flossing in this equation because it's what makes all the difference. Doing the minutes every year, as I said, is a tax write-off, having a corporate meeting. And even if you're by yourself, go to dinner, get yourself something real nice, go to the spa, write down what's happened in the company for the last year. We actually have a service for a couple hundred dollars a year, literally, where we give you a questionnaire and you fill it out and it asks you questions that you should be answering that go into the corporate book. When Yang took these Yahoos to court, they said, produce your annual minutes, produce your corporate books, show us what you've got. They didn't have anything. They have done none of that. They lost. Yeah.

unknown 11:43

Yeah.

SPEAKER_01 11:44

And I think that's what you need to understand. If your LLC gets sued, you're going to have something called interrogatories, and maybe you even have depositions, but there's going to be a request for production of documents, some written interrogatories you're going to have to respond to. And if the plaintiff believes or knows that your LLC is worthless and doesn't have assets itself to satisfy the judgment, they're going to try to find ways and they're going to ask questions and make you produce documents to show you treated that LLC properly. Because if you didn't, they're going to blow through it to get you the owner of the business. And that's exactly what happened in that case. During discovery, they made production requests for all the corporate documents and all these formalities that they should have been doing. And they realized there weren't any. Nothing was produced. And they used that as the basis with the court to say they're not doing minutes. They don't have all the other corporate formalities and documents that you should have with an LLC. They got into the misappropriation of funds and they and they made that alter-ego argument. It is the classic one that a plaintiff can use to blow through your LLC to say, you

Bookkeeping And Separate Bank Accounts

SPEAKER_01 12:50

didn't treat this like an LLC. You just treated this poorly. Classic.

SPEAKER_00 12:54

Like never going to a land war with a Sicilian.

SPEAKER_01 12:57

I mean, that's just one of the classic rules. Yeah, we we know this. We know this. Never go to uh what is that? Princess Bride. Princess Bride.

unknown 13:06

That's not true. Yeah.

SPEAKER_00 13:07

Never go into a land war with a Sicilian. Okay, but you're you may think, well, guys, I'm sure this case got appealed. Yes, it did. It went to the New York Appellate Division, and they said it was undisputed that during discovery, the defendant produced nothing. They did not have any of this. So um it it just blatant uh disregard for the LLC corporate veil. Now let's hit the third point bookkeeping records. When you set up an LLC, it requires a bank account. Every LLC we set up and all these cleanups we do, half of them they don't even have a tax ID number. So we need to get you a tax ID number. You've got to go with a bank packet, go down to the bank and open up your business bank account. We've had clients do selfies with their corporate books and show go show and go and go down to the bank. It's actually pretty cool. We've had bankers literally tell our clients, this is the cleanest bank packet I've ever seen. And they walk in, they get their bank account set up, and then you start doing, yep, it's called bookkeeping. What goes in, what goes out. And like Matt said earlier, you don't pay for your tennis club membership out of the LLC. You pay for what's business expenses, and you only deposit business income and have a good set of books. And it doesn't have to be over the top. These virtual assistants in other countries can help you with bookkeeping. Just do it. You cannot ignore this.

SPEAKER_01 14:41

Yeah, and I think, I mean, obviously, bookkeeping, we can talk forever about this, gets you into how you're better saving on taxes. The most organized clients with their books are the ones that save the most taxes because they don't forget all the little things that that is actually a write-off. Um, and uh, Mark, threw that little tennis club comment in for me, because he knows I've been playing some tennis. Mark, what if I'm networking while on the tennis court? You know? Ooh, ooh. I mean, there's a little pun there. Networking, I think that's a good idea. I bet you the last part.

SPEAKER_00 15:06

I'm working the net. Yeah, I know you know you can't write off your tennis club membership, but you probably wrote off that steak sandwich and that steak sandwich uh when you were at the club. Absolutely.

SPEAKER_01 15:17

Absolutely, because that was we were talking business. Um, so but okay, so I think I don't want to like scare you out of an LLC. I mean, I want to come back to the first point of like like Mark and I both, I don't know, like 20 plus LLCs or something. I don't even remember, I can't even keep track of how many. Like I'm using personally, okay, maintaining them, getting the right document set up, not cutting corners. And these are like they're not difficult things to do. They're just like no one's checking to make to say you have to do this. And these things don't matter until you get sued. And so I think it's the easiest one people let go by the wayside to be like, well, the bank didn't make me have this, well, the IRS didn't make me have this for my tax return. And so I was like, Oh, I'm just not gonna do it. No, no, no, no. Like, this is why do these things exist in the first place? Like, do you think these documents are just out there in like operating agreements and minutes and all those things and resolutions and all these like corporate formalities are just out there as just like a thing for fun? No. People use them to protect themselves

LLC Cleanup Services And Final Takeaways

SPEAKER_01 16:20

in this situation that we're talking about here. So don't cut the corners and get focused. And our law firm, like when we mentioned this at the top, uh KQS lawyers, our law firm, we have attorneys helping clients clean up. We'll look at what you have and fix it. And we'll include the documents we have. There might be other issues we might need to address on it on your tax planning or strategy on it. Do you have the right tax election for it? I mean, we can kind of do a whole 360 analysis of what's going on with that entity, but a minimum, we can get it cleaned up and fixed.

SPEAKER_00 16:50

Yeah, and I said at the very beginning, it does not have to be expensive. Uh a cleanup at our firm is typically less than a new setup. We do recommend you get a comprehensive trifecta at the time. Let's really get a plan in place. But if you just need the cleanup, you can book a call down in the description, get that done. And then our company maintenance service, because none of you want to do this. I don't want to do this. I don't. I literally am a client of my own company. And Patty and I get our little ping via email, and our staff goes, it's time to do your minutes for this entity. And it's $200 a year per entity. And we're gonna line you up with our sister company, Main Street Business Services, that'll just handle that on a regular basis. And it's it's it's cheaper than an insurance policy, but it is the best insurance for your LLC. That's what makes it all come together. So take some action and get cleaned up. This is a great time of year because it's kind of the summer doldrums or you're going into the fall, it's school time. I always thought that to me, the new year was always in the fall because just like you get your new set of clothes and you go to school and and you and it is that's when this that's when the year starts for me. Football season's around the corner. It's just sun, it's such a fun time of year. Let's get your entities cleaned up at the same time.

SPEAKER_01 18:13

Yeah, and thanks for everybody for tuning in to this episode of the Main Street Business Podcast. Please make sure, no matter where you're catching it, that you're subscribed, that you're liking it and sharing it with your friends and family. We hope to be a part of your American dream. So stay subscribed and tuning in. We'll see you next time.