Many people form companies, also called corporations, to run their businesses, for the purpose of limiting liability. When a company is sued, the maximum amount that can be extracted from it is the paid-up value of its shares. In other words, if two people form a company and it issues each of them with 100 $2 shares, the paid-up capital of the company is $200. That is all that is all that anyone who sues it can be awarded. For this reason, in many parts of the world, like the UK and Australia, the word “Limited” appears in almost every company’s name.
For that very same reason, many people or entities that do business with companies also require personal guarantees from the directors of the companies. For example, it is very common for landlords to request such guarantees when leasing premises to a company, or for banks to request directors’ guarantees when making loans. By doing this, the other person or entity will bypass the limited liability of the other party, e.g. the tenant or borrower, and reach someone else who doesn’t have limited liability, i.e. its director(s).
In order to shield their personal assets from litigation, many company directors adopt asset protection strategies, such as placing their homes and other valuable property in trusts, or in the names of third parties, like their spouses. In other words, if you sue me, you’ll discover my pockets are empty.
This kind of strategy isn’t always effective. Putting property in another person’s name is a risk: what happens if they die, or, in the case of a spouse, what if they divorce you? Putting property in a trust makes it safer from claims by outsiders to the trust, but the courts have developed rules to ignore trusts where the arrangement looks artificial and only designed to defeat creditors.
In any case, it is possible to employ legitimate strategies to protect assets, and anyone going into business should consider whether implementing an asset protection strategy is appropriate. Another way to reduce the impact of litigation is to obtain insurance.
[This blog post was written by James Irving, business lawyer in Perth, Western Australia. Visit the Irving Law website to learn more about James and his services. This post is not intended as advice for any particular person, and reflects the law in Australia at the time of writing. Photo credit: Empire Plaza by Jessica, courtesy of Wikimedia Commons and used here under a CC BY 2.0 Creative Common licence.]