I had a great discussion with a buddy during our lunch meeting yesterday and it raised this topic; Can I be judgement-proof? Let’s dive in!
*Disclaimer- I am not a lawyer and this is not legal advice. ALWAYS seek counsel when exploring topics like this.
If you think asset protection is just a thing for HNW and UHNW people, think again. According to data from the National Center for State Courts (NCSC), approximately 15-20 million civil cases are filed annually in state courts alone. This figure includes a wide range of civil cases, such as personal injury claims, contract disputes, family law cases, and property disputes.
At the federal level, civil case filings are much lower. In 2022, the U.S. federal courts recorded around 270,000 civil cases. Federal civil cases often involve matters such as constitutional challenges, federal laws, or disputes between parties from different states.
State courts handle the overwhelming majority of civil lawsuits, while federal courts focus on cases that involve federal questions or diversity jurisdiction. The numbers can fluctuate yearly depending on factors like economic conditions, legal trends, and changes in legislation.
I happen to live in the State of Florida, which ranks 4th in the nation falling behind California (sorry Stanley!), Texas, and New York. It feels like anyone can sue anybody for almost any reason! While this could take us down the rabbit hole of asking why is our legal system so screwed, let’s save that topic for a rainy day!
What does it mean to be Judgement-Proof and is it possible? The short answer is No, however, there are some steps you can take to protect your assets. Creating a business structure that makes you judgment-proof refers to designing an organization and personal asset structure that shields your assets from potential creditors or lawsuits. While it’s impossible to be completely immune to legal judgments, there are various strategies that can significantly reduce exposure. Below are several tactics, including asset protection strategies and business structures that can help:
Form an LLC or Corporation
Limited Liability Companies (LLCs) and corporations provide legal separation between personal and business assets, meaning your personal assets are generally protected from business liabilities. LLC’s can help ensure that corporate formalities are followed (e.g., keeping personal and business finances separate), as courts may pierce the corporate veil if you don’t. In my personal opinion the states of Delaware, Nevada, and Wyoming offer strong asset protection laws and business-friendly courts. The primary reason for forming an LLC is to limit the personal liability of the members. If the LLC incurs debts or faces lawsuits, the personal assets (homes, cars, personal bank accounts) of the members are generally protected. Creditors can only go after the assets of the LLC itself, not the members’ personal property. For example, if an LLC is sued for breach of contract or a customer slips and falls on the business’s premises, the members are not personally liable for the lawsuit.
In the event that the LLC faces litigation, the company itself is the target of legal action rather than the individual members. This provides a legal shield against personal lawsuits tied to business activities. There are exceptions to LLC protection, known as “piercing the corporate veil.” If the owners of the LLC do not keep the business separate from their personal dealings (e.g., commingling personal and business funds), or if they engage in fraudulent or illegal activities, courts may hold them personally liable.
Finally, there are tax flexibility options afforded to an LLC as well. While this is more of a financial benefit than a protective one, LLCs can choose how they want to be taxed (as a sole proprietorship, partnership, S-Corporation, or C-Corporation), allowing them to potentially reduce tax liabilities, which indirectly enhances financial security.
Create Holding Companies
A holding company structure allows you to separate ownership of assets from operational liability. For example, one company can own valuable assets like intellectual property or real estate, while another conducts operations. The holding company remains insulated from liabilities arising from the operating company. A holding company shields the parent company from the liabilities of its subsidiaries. If one subsidiary faces financial trouble, litigation, or bankruptcy, the liabilities typically remain with that subsidiary and do not extend to the holding company or other subsidiaries. This separation of legal liability can help protect the assets of the holding company and other parts of the business.
By placing valuable assets (e.g., intellectual property, real estate, patents) in the holding company rather than in an operating subsidiary, the holding company can protect those assets from creditors or legal actions against the subsidiary. If a subsidiary faces a lawsuit or bankruptcy, the assets held in the holding company are generally shielded from seizure. A holding company allows for centralized control and management of multiple subsidiaries. This structure enables efficient decision-making across diverse business units while allowing the subsidiaries to operate independently in their respective markets. The holding company can also provide strategic guidance, capital allocation, and oversight.
Holding companies can raise capital or enter new markets more easily by acquiring shares or assets in other businesses. Since a holding company can operate as a pure investor, it can diversify its investments by owning a range of subsidiaries in different sectors or regions, reducing risk through diversification. A conglomerate like Berkshire Hathaway is a prime example of a holding company that owns various businesses across sectors, from insurance and manufacturing to energy and retail. By keeping each subsidiary as a separate entity, Berkshire Hathaway shields itself from the financial and legal risks of individual companies while maintaining centralized control.
I will digress here for a brief moment and add these thoughts as it relates to titling assets like high-end cars. (let’s save toys like yachts, etc for another day). People often choose to title and register high-end cars, such as luxury vehicles, exotic cars, and RVs, in Montana primarily to avoid sales tax and vehicle use tax. Montana has become a popular state for this practice due to several key factors:
Montana does not impose a sales tax on vehicle purchases, which is a significant incentive for those buying expensive cars. In states where sales tax can range from 5% to 10%, the savings on a high-end vehicle purchase can be substantial. For example, buying a $500,000 car in a state with a 7% sales tax would normally result in a $35,000 tax bill, which can be avoided by registering the car in Montana.
In addition to no sales tax, Montana has low vehicle registration fees, making it even more attractive for owners of high-value vehicles. These fees are minimal compared to states with high annual registration costs, particularly for luxury or exotic cars. To take advantage of Montana’s tax benefits, car owners often establish a Montana LLC. The car is then purchased and titled under the name of the LLC. Since the LLC is legally based in Montana, the vehicle is registered there, even if the owner lives in a different state. Unlike many states, Montana does not require vehicle owners to be residents of the state to register a vehicle. This makes it possible for non-residents, particularly those in high-tax states, to register their luxury vehicles there without having to live in Montana or keep the vehicle in-state.
Thanks for perusing Part 1 of Can I be Judgement-Proof! Part 2 is in the works and will be up next! – Dan