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Strategies To Protect Valuable Corporate Assets
By Richard A. Chapo, Esq.

Asset protection is a primary reason for incorporating your business. By incorporating, you create a shield between potential liabilities arising from the business and your personal assets. Many businesses, however, fail to extend this asset protection to their key assets.

When a corporation is created and run correctly, the only assets at risk to creditors or lawsuits are the assets in the corporation. Liquid assets such as cash and account receivables are exposed to the risk of doing business and there is not much that can be done to isolate that risk. Non-liquid assets, however, can be protected if prudent planning is undertaken. This protection is afforded by undertaking a double incorporation strategy.

A double incorporation strategy is used to protect assets from the risk of doing business. The strategy simply involves the creation of two corporations. The corporation dealing with customers or clients is known as the "At Risk" entity, while the second corporation is known as the "Asset Corporation." The strategy involves placing all non-liquid, valuable assets in the Asset Corporation" and leasing them to the "At Risk" corporation. If the At Risk corporation is sued or runs into financial difficulties, the assets held in the Asset Corporation are protected from legal attack. Let's look at a few examples.

Manufacturing Example

A corporation is in the business of manufacturing plastic parts for customers. The plastic manufacturing equipment used in the business has a value of many thousands of dollars. Due to the nature of the business, the corporation is at risk of being sued if the plastic parts do not meet design criteria or subsequently fail. If the corporation is sued and a verdict is obtained, the manufacturing equipment could be seized and sold to satisfy the judgment. Without manufacturing equipment, the corporation will be unable to fulfill orders, face further breach of contract lawsuits arising from this failure and likely face bankruptcy. With proper planning, this risk can be eliminated.

Using the double incorporation strategy noted above, the business owners will form two corporations. The first corporation will obtain orders from third parties and fulfill them. The second corporation will be formed for the purpose of owning the manufacturing equipment. The second corporation will then lease the equipment to the first corporation for use. If the corporation fulfilling the orders from third parties is successfully sued over a product defect or breach of contract, the manufacturing equipment will not be at risk since it is not an asset of that corporation. By using the double incorporation strategy, the business owners have minimized the risk of losing their valuable, non-liquid assets.

Medical Practice Example

A physician decides to open a practice, which puts him at risk of being sued for medical malpractice or other claims. In opening the practice, the physician must obtain various medical equipment that is both expensive and carries a significant resale value. Items can include patient examination chairs, surgical and radiological equipment, etc. To isolate this equipment from the risk association with litigation, the physician should form a corporation for the purpose of owning the various equipment, which is subsequently leased to his practice. By taking this step, he protects his assets from the risk of litigation.

The double incorporation strategy is a fairly simple strategy that carries significant asset protection value. The process involves the creation of two corporations, as well as proper documentation for the leasing of the assets between the companies. Further, you must understand that the corporations must be treated as separate entities and corporate formalities must be followed for each. By meeting these nominal requirements, you can extend the asset protection element of incorporation from your personal assets to the key assets of you business. In the highly litigious California business culture, the double incorporation strategy is highly recommended.

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Richard Chapo is the lead attorney for SanDiegoEsquire.com, based in San Diego, California. He can be contacted at Richard@SanDiegoEsquire.com. or 619-992-1867. This article is for general education purposes and does not address every facet of the laws surrounding the subject. Nothing in this article creates an attorney-client relationship.