Author: Andrew M. Thaler
Simply incorporating a business shields the owners from most personal liability exposure. However most small business owners often sign papers they do not understand. Moreover many do not even keep copies of what they signed for future reference. While it may be difficult, co-signing or personally guaranteeing a corporate obligation should be avoided if possible. All paperwork should be maintained for future reference. Very often clients do not even know that they are personally liable for business debts until they are sued in their individual name.
If married and starting or engaged in a business, consideration should be given whether it is advisable to transfer the marital residence to the other spouse if that person is less likely to be at potential personal financial risk in the future. This assumes a solid marriage and that the conveyance is not a fraud on creditors (which is a whole other article in itself).
If a home is jointly owned by a husband and wife, in New York a judgment creditor of only one spouse is prohibited from selling the marital home to satisfy the debt. However judgments obtained against one spouse and filed with the County Clerk will remain a lien against that spouse’s interest for ten years. The lien can be renewed prior to the expiration of the tenth year. The judgment will also incur statutory interest of 9% a year, a tremendous interest rate in today’s market. When owners seek to refinance or sell their home the judgment will have to be satisfied. In a bankruptcy scenario, (if appropriate) a judgment debtor that owns a house will be able to shield and keep up to $170,825 (in the New York Metropolitan area) from a judgment creditor. The same exemption applies in a forced judgment foreclosure sale. Interestingly some judgment creditors with liens on real property that have a lot of equity and are capable of being foreclosed upon (i.e. not owned with a spouse) are quite comfortable sitting with their judgment knowing that they cannot generate a 9% rate of return on their money elsewhere.
Business owners in distress often sign Confessions of Judgment (usually associated with merchant cash advances) take out home equity loans or grant collateral mortgages on their home to lenders to secure business obligations. This places their most precious asset at risk when other options may have been available to discharge that debt and preserve exempt equity in their residence. Worse is where a spouse, who is not obligated for the debt or involved in the business, agrees to guarantee the debt or consents to placement of a mortgage against their interest in the home.
Similarly, pensions and retirement accounts that are outside the reach of most creditors (some exceptions: IRS debt and domestic support obligations) are often lost by being sunk into businesses destined to fail. An entire lifetime of savings meant for retirement can be lost very quickly if proper planning is not done.
Fiduciary taxes, (sales and withholding) carry personal liability to not only the officers of a company but to those with check writing privileges. These taxes cannot be discharged in bankruptcy.
Sometimes it makes sense to invest one’s personal funds or those of willing family members into a business. Too often those transactions are not supported by proper paperwork and the people the business owner wants to protect the most, including themselves and family members, are not protected at all. Transactions with family members should be documented the same way an arms-length creditor would require. The transaction will then more likely pass muster as a legitimate debtor/creditor relationship, not a gift or a capital contribution. The devil is always in the details. If the transaction is well thought out it can accomplish the intent of the parties and less likely be exposed to outside legal attack when things do not go as planned.
The bottom line is that everyone needs to think about what might happen if a catastrophe arises for them. Consulting with the proper professional can likely lessen the financial damage of an unexpected event.