How Forming an LLC Saved My Business

Forming an LLC Saved My Business! This dramatic statement from a customer this week sent me into a tailspin. I immediately had more questions than I could ask in one phone call, but we did have a great conversation that let me know why he felt that forming an LLC had been so important for him and perhaps of equal importance, further steps he had taken to protect his assets that also came into play.

Let me start by telling you his story. If it sounds like fiction, let me assure you it’s not. It is, however, a great example of how quickly a simple situation can spin out of control…leading to a potentially disastrous lawsuit for a small business owner.

Here is the background. The customer’s name is Dan and he has a number of small rental properties. Dan came to us when he decided on forming an LLC. We created the LLC for him and he transferred the ownership of each of the properties into the LLC. He told me that his decision had been made after several conversations with other real estate investors and attorneys, based on stories he heard from them about being sued by renters. Recently, he has been able to add his own nightmare to the stories circulated by their group.

About 2 years ago, one of his renters went into the kitchen of the home she rents from him. Dan tells me that small, green lizards are common in the area and one was apparently on the kitchen floor. The no doubt ferocious lizard was later stated in the lawsuit to have been about 1 ½ inches long, frightening by any standard. According to the lawsuit, the tenant, upon spotting the lizard ‘ran screaming from the home in fear for her life’. This resulted in her falling down the steps at the back of the home and injuring herself. Subsequently, she requested almost $150,000 in reimbursement for hospital expenses and pain and suffering.

Sound ridiculous? Apparently, other people thought so, too. Especially after she was unable to produce even a single hospital bill or other proof of expense related to the injury. Obviously, that didn’t stop her from suing Dan and the lawsuit dragged on for almost 18 months before finally being dropped.

So why does Dan feel that forming an LLC played a role? It seems that the tenant felt Dan had money and she believed that filing a lawsuit against him would either scare him into settling with her or possibly give her a shot at a large windfall. Ultimately, she learned that the LLC had very few assets. Each of the homes is mortgaged and the LLC doesn’t actually have other assets. Since she was actually suing the LLC, those already heavily mortgaged assets were all she could go after. Forming an LLC had shielded Dan’s personal assets from the lawsuit and he believes that is why she finally gave up.

Here is another good point. After forming an LLC, Dan went to his insurance agent and purchased policies to protect his properties and a separate policy on each property for liability. After hearing his story, I can only say that was a great idea. His insurance company took the lead in fighting the lawsuit since they would be out money if he lost. So for 18 months, Dan had big corporate lawyers fighting his case and he was eventually able to walk away without losing anything!

Just to recap, here are the things Dan did to layer protection on his company.

1. Forming an LLC
2. Purchasing liability insurance for each of his rental properties
3. Using mortgages on each property to effectively reduce their value in the lawsuit

If you are in a similar situation, it may be worth your time to speak with some of the professionals you work with to determine if this or a similar strategy could work for you. It shouldn’t take long to find out and you probably have the right people on speed dial on your phone. Try you attorney, insurance agent and accountant.

Do you have a similar story about the effect of forming an LLC or incorporating a business? I would love to hear it.

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