by William Bronchick, Esq.

Over 80 million lawsuits are filed every year in the United States. If you are in business, you should be thinking about the risks involved. The following are some of the most common pitfalls that lead to liability and lawsuits for small business owners and how to avoid them.

Pitfall #1: Doing Business as a Sole Proprietor

Most people who go into business do so as a "sole proprietor." This means that they are doing business as an individual or a "d.b.a." (doing business as). This scenario offers absolutely no asset protection, not to mention poor tax benefits. If the business is sued, all of the personal assets of the individual are at risk. For less than $100 in most states, you can form a corporation to do your business or trade. If properly maintained, a corporation will shield your personal assets if the business is sued or goes bankrupt.

Pitfall #2: Doing Business as a General Partnership

:Doing business with a partner is even worse than doing business as a sole proprietor. A "partnership" is formed when two or more people decide to do business together for profit. It does not require a formal partnership agreement or the filing of any official documents, although it is often done that way. A partnership can be created even if the parties did not intend it!

Here is the problem with a general partnership: if your partner does something foolish, you are liable. That right! If you allow your partner to commit the partnership to a contract, the partnership and its partners can be held liable for that debt. If your partner is negligent or incurs a debt on behalf of the partnership, you are on the hook - even if your partner files bankruptcy!

If you intend to business with partners, consider a corporation or other limited liability entity. It is just as easy to set up for two people as it is for one.

Pitfall #3: Using a Corporation Improperly

A corporation is good, but only if you use it properly. Many people pay an attorney up to $1,000 to setup a corporation, then they take the corporation's minute book and stick it in the closet. A corporation will not shield you from personal liability if you do not follow corporate formalities! Even worse, if the IRS audits you, they can set aside the corporation and hold you personally liable for the taxes!

At least once a year, have your attorney and/or tax advisor review your corporate records and practices.

Pitfall #4: Personal Guarantees

In some situations, such as a bank loan or line of credit, it is inevitable that you must sign personally. However, it is not necessary to give a personal guarantee in every situation, simply because they request it. Often, vendors of your business will request that you sign a personal guarantee of a corporate liability. If they are not extending you credit, you should simply refuse. For example, if a landlord requests a personal guarantee on a lease, offer a larger security deposit instead. Or, you can negotiate so that after two years of prompt payment, your personal guarantee is not necessary.

If you choose to sign personally on an obligation, do not make the mistake of allowing your spouse to co-sign with you. Unless your spouse is involved in your business, there is no reason for a vendor or bank to require your spouse's personal guarantee.

Pitfall #5: Failure to Maintain Adequate Insurance

Don't be cheap. Insurance will protect you in most circumstances. If you keep the minimum insurance, increase the liability limits. You can usually double your liability insurance for a relatively small amount. Keep in mind that if your insurance is not adequate to cover the claim, the injured party can go after your personal or unincorporated business assets for the difference.

Insurance also gives you an attorney in an event you are sued, even if the claim is settled before trial. The duty of an insurer to defend (pay for your lawyer) is much broader than its duty to indemnify (pay for claims against you). Even if the lawsuit is completely bogus, the insurance company will provide you with a lawyer, saving you thousands of dollars.

Pitfall #6: Sexual Harassment in the Workplace

Sexual harassment is another hot issue for the 90's. If you own a company with employees, be aware of what goes on. Even if you don't personally engage in any conduct which is harassing in nature, you can be sued if your company permits a "hostile" environment. Make certain you have written company policies that are given to all of your employees that specifically state that sexual harassment will not be tolerated. Set up an internal complaint and investigation procedure within your company. Immediately investigate and resolve any issues within your company, especially those that involve people of the opposite sex. Be especially aware of these events if you have a company picnic or office party.

Pitfall #7: Using "Independent" Contractors

If you regularly pay "contract" employees, you may be treading thin ice. If your "independent contractor" commits a negligent act and a third party is injured, you can be held liable. The problem with this area of law is that it does not matter whether you thought the individual was an independent contractor or an employee. The law presumes an individual to be an employee by balancing some of the following factors:

Did the individual work your hours or his?

Did he use your tools or does he have his own?

Does he do work for other people, or just for you?

Did you personally supervise the work?

Did you pay him daily, weekly or upon completion?

Was there a written contract?

These are only some of the factors, but you can get a general idea of what factors are relevant. If the court considers the individual to be your employee, you are responsible for his actions.

Pitfall #8: Failure to "Get it in Writing"

Always leave a paper trail. Whenever you speak with someone at a company, the IRS or any governmental organization, get it in writing. If they won't give it to you in writing, send them a "self-serving" follow-up letter summarizing your conversation. Their failure to object to its contents may be deemed an admission of what the letter states. Keep a copy in your file in case to have to prove the oral conversation in court.

Remember, it's not what happens, it's what you can prove in court (also known as the "O.J. Rule")! The written word is your most powerful weapon in Court - use it.

Pitfall #9: Opening Your Mouth too Wide

If you are involved in what could potentially be a lawsuit, think before you act. Do not write offensive letters to your adversary stating your legal positions. Successful litigation involves some element of surprise. State firmly, but vaguely, that you intend to pursue your legal remedies . . . that's all!

Pitfall #10: Owning All of Your Assets in One Business Entity

Don't place all of your eggs in one basket. While a corporation or limited liability company may shield your personal assets from business liabilities, it will not shield the business's own assets. If your business entity has a substantial amount of debt-free equipment or real estate, consider spreading out the risk. Create one or more corporations or limited partnerships to hold title to the assets, then have your business lease the assets back.

John D. Rockefeller once said, "Own nothing, but control everything." The more assets your business owns, the more likely it will be sued.

For comments or questions, e-mail bronchick@legalwiz.com

by William Bronchick, Esq.

There are over 80 million lawsuits filed every year in the United States. Landlords and real estate investors are especially susceptible to liability. Are you a target? Are your assets easy to locate? Is your real estate titled in your name?

You wouldn't walk around with a financial statement taped to your forehead would you? So why would you have your most valuable assets exposed to public scrutiny? Anyone can go down to the county courthouse or recorder's office and look up the owner of any property. Real estate records are now computerized, so all of your real estate holdings can be located at the touch of a button!

Any mortgages on your property will be recorded as well. Most recorded mortgages will state the amount of the original principal balance and the date the mortgage payments began. All one has to do is figure out the balance of your mortgage and subtract that amount from the market value of your house. Bingo! Now they know how much equity you have and hence whether suing you is worthwhile.

If a tenant or creditor is contemplating suing you, he will make an appointment with a lawyer. Unless he can afford an attorney by the hour ($150 and up), he will likely seek a "contingency-fee" lawyer. A contingency-fee lawyer does not charge by the hour; he charges a percentage of whatever he collects. Most contingency-fee lawyers will not take a case unless there is something upon which to collect. If you have no real estate in your name, then finding out your ownership interest will not be easy for a typical lawyer. It's not that lawyers are lazy. It's simply a matter of allocation of resources; lawyers focus on cases they can win and collect. If they don't find any assets in your name (and there is no other apparent "deep pocket"), they probably won't take the case. As you can see, appearing "broke" is the best lawsuit-repellent money can buy!

There is another problem with owning real estate in your own name. If a judgment is obtained against you and filed in any county in which you own real estate, all real estate in that county will have a lien attached to it. You cannot sell or refinance any property in that county, since no title insurance company will guarantee a clean title. You're stuck until you pay off the lien.

Some people use a corporation or limited liability company to hold title to their real estate. While these entities will protect you, they will not protect your property. If you own all of your properties in one corporation, a judgment against the corporation will create a lien on all property owned by the corporation. Furthermore, the directors and officers of a corporation are public record, so a corporation will not hide your ownership.

The solution for holding title to real estate is a land trust. A land trust is a revocable, living trust used to title ownership of real estate. Title to the property is held in the name of a trustee, who is forbidden to reveal the beneficial owner. The beneficial owner or "beneficiary" can be an individual, corporation or other entity for further protection.

Land trusts were first used in Illinois, hence the nickname, "Illinois Land Trust." In nine states (AL, FL, GA, HI, IL, IN, ND and VA), land trusts are specifically recognized by statute. In most other states the validity of land trusts are supported by common law and general trust principles (land trusts are not recognized in TN & LA).

A land trust, if properly setup and implemented, will hide your name from the public records. No one will know who owns the property but you, your attorney and the trustee. If a judgment is entered against you, a lien will not automatically attach to the property, since title is not in your name.

A transfer of realty into a land trust virtually no income tax consequences. A land trust is considered a revocable "grantor" trust under the Internal Revenue Code, so it does not require a separate tax identification number or income tax return. Thus, you continue report the property for income tax purposes as though you still own it. Furthermore, a transfer of property into a land trust will not usually trigger the "due on sale" clause of your mortgage.

A land trust will allow you to assume an FHA or VA loan without recourse. Anyone can assume an old FHA or VA loan without qualifying, but few investors realize that such an assumption is with recourse. If the investor sells the property and the buyer assumes then defaults on the loan, the investor (and anyone else who previously assumed the loan) may be held liable. If a land trust is established to take title to the property and assume the loan, there is no recourse against the beneficiary. Furthermore, the loan will not appear on the beneficiary's credit report as a liability.

So What are your waiting for? Get that Property Out of Your Name!

For comments or questions, e-mail bronchick@legalwiz.com.