Author: Eric Townsend
First of all, if you’re saying to yourself, “this doesn’t apply to me, I never chose any entity”, you are exactly my target audience. More investors are returning to the business of buying properties to rehabilitate and resell (flip). These can be profitable endeavors as prices seem to have bottomed. Unfortunately, many of these investors are purchasing these properties with other investors and using agents (like contractors) to do some of the repairs and work without consideration of the entity in which they operate. This could leave these investors open to immense liabilities because they did not take a few simple steps to form an entity providing them limited liability.
In California the default entity when a person does business with another, without forming a recognized entity by the State, is a general partnership. This means that the person is generally liable to any creditor for the actions of any of the general partners or agents who are acting on behalf of the general partnership. If a partner or agent accepts credit from a lender, or is found liable in a civil action for injuries that arose from the actions of a partner/agent while acting on behalf of the general partnership, then those creditors may seek their damages generally from all partners.
A simple example, a General Partnership “GP”, made up of Partners A, B, and C, hired a contractor as their agent to install a new roof on a property they intended to rehabilitate. Partner A had only contributed $5,000 to the GP, which was used as the down payment to buy the investment property. B and C had contributed $10,000 each to hire a contractor to fix the roof. When installing the roof, the contractor did not fully latch the mechanism to secure the a-frame structure. Half-way to the desired location, it fell upon an unsuspecting victim V. The V was unable to work again and was awarded a judgment of $250,000 in damages. In this case the GP would be liable for these damages (i.e., the injured party can seek these damages from any and all of the general partners including judgment liens on their personal property). Partners B and C had no personal assets for the V to go after, but A had a property worth $250,000 that was owned free and clear. So a lien was placed on A’s property and then sold to pay off the judgment. A then sought contribution from B, C and the contractor for the $250,000 and prevailed in that action. Unfortunately, the following month B, C and the contractor declared Chapter 7 bankruptcy and the general partners’ claim against them as judgment creditors was liquidated. For a $5,000 investment A lost his home.
Could this have been avoided? The answer is absolutely! Anyone who registers a business with the Secretary of State of California in a recognized limited liability entity under California Code, and operates legally under that business name, is only liable for their own acts and the amount of money they contribute to that business. So had A instead decided to form a LLC or corporation, his maximum liability in the above example would have been the $5,000. Is it worth it to spend the time, cost, and effort to limit your liability? You be the judge.
If you have any questions or comments regarding this blog email us at blog@lauruslaw.com
www.lauruslaw.com
No comments:
Post a Comment