Separate and Document Ownership of Assets

 

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As we've discussed elsewhere, an owner can fund the business entity as an owner and as a creditor with debt such as leases and loans when using operating and holding companies.

In order to avoid application of the alter ego theory by the courts when an outside creditor seeks to pierce the veil of limited liability, assets must be associated with a particular entity.

So when assets are transferred to a business entity in exchange for an ownership interest, care must be taken to ensure that legal title is effectively transferred. Transfer of real estate and motor vehicles requires that a formal document of title, that takes a certain form, be executed and recorded. In other cases, a written document, that is more flexible in its form, should be used to transfer title (see our discussion of transfer issues).

In short, the business entity should hold title to the assets it owns. Similarly, bank accounts and credit cards should be established in the entity's name.

Warning Frequently, the small business owner will continue to use an existing checking account, stationery or legal forms that were established in the owner's personal name or the old business's name. Doing this can trigger a piercing of the veil of limited liability, because the new business will, in effect, be using assets that it does not own, or have the right to use, under a written agreement. Close old bank accounts and credit card accounts. Discard unused checks. Open new accounts and credit cards in the new entity's name. Discard old stationery and legal forms. Have stationery and legal forms printed in the new entity's name. The cost of doing this is minimal, especially in comparison to the risk of loss that is eliminated.

An owner could run into trouble if this separateness is not maintained. Be careful to avoid a pattern of co-mingling of assets. And if certain assets are mixed-use, follow certain guidelines to steer clear of the alter ego theory.

In addition, when leases and loans are used in funding the business entity, written agreements must be recorded. These agreements also should be formally authorized by the entity if the management structure requires such authorization (e.g., by a majority of the LLC managers). Proper recordkeeping is vital to ensuring your limited liability.