Hopscotch Asset Protection

A client posed an interesting California asset protection question the other day: “If my business gets sued, why can’t I just shut it down and open an new business doing the same thing?”  This client is really thinking about asset protection planning.  Her point is pretty straightforward.  The business she owns is a separate legal entity.  If that entity gets sued and has a judgment entered against it by a court, why not just “wind up” the affairs of that entity and get rolling with a new limited liability company?  That makes sense from a common sense standpoint, perhaps, but it’s a good thing she has an asset protection attorney to keep her out of trouble.

Successor Corporation Theory

Most states have laws that address the scenario described above.  Bankruptcy trustees are particularly well-acquainted with these laws, since it’s not uncommon for a debtor to try to transfer assets out of a defunct company, set up operations under a new entity-name, and then file for bankruptcy protection on behalf of the defunct entity . . . all in the name of asset protection.  Unfortunately, post hoc asset protection planning almost never works.

Courts and most aggressive plaintiff’s attorneys are wise to these practices as well and have developed a theory of law called the alter-ego theory for dealing with situation where it seems that business is continuing as usual but under a new name.  The alter-ego theory will impose liability on a new business enterprise where it seems that the new business is simply a continuation or the alter-ego of another business entity.  Of course, it only matters when the “other business entity” is subject to a judgment or is otherwise a debtor.  In other words, when a new business uses the assets of a debtor business to begin operating, those assets can be recovered by creditors of the debtor business.

Some things that courts look at when deciding whether a new business is an alter-ego of a debtor business include commonality of ownership, location, contact information (e.g. phone numbers), goodwill (e.g. client contacts), type of business, and the physical assets required to conduct business.

It’s pretty safe to say that hopscotching assets from one business entity to another is not a good form of asset protection.  There are, however, ways to protect your assets before you need to think about creating an alter-ego (which won’t work anyway).  The key to asset protection planning is to be proactive.