Asset Protection Misconception Number 1: Insurance Protects You
You know what I hear the most from my real estate investor clients, “I thought all I needed to protect my assets was a general liability insurance policy?” This couldn’t be more further from the truth.
In law school, I was a Research Assistant to one of the country’s preeminent insurance law professors — the late Professor Alan Widiss. My responsibility each week was to copy every appellate court case from around U.S. involving uninsured and underinsured motorist insurance, and to highlight the court’s main points in each case. I also took every insurance law class that he offered. What became clear over the years of reading thousands of insurance law cases is that the insurance companies liked playing games. They were always trying to figure out how to avoid covering claims.
I have nothing against insurance, per se. Insurance is a key first line of defense when it comes to asset protection. But they are in the business of making money. And they do that by taking in more in premiums than they pay out in covered claims. When you get insurance, you’re betting against yourself. An insurance company is like the house in a game of casino poker. In the end, they never lose. And even if the insurance company pays out for a claim, you still lose because they’re going to raise your monthly premium.
The truth is you do need insurance. But insurance alone won’t be enough to protect your assets. Insurance policies include what are called “exclusions”. Insurance companies include exclusions in your contract to minimize their losses. Remember, their goal is to make a profit, just like you.
Unfortunately most people won’t sit down and read these exclusions. And even if they did, they probably wouldn’t be able to understand the complex legal language insurance companies use in their contracts. What these exclusions do is prevent you from suing a company for any particular reason, as outlined in the “exclusion”. For example, you, the landlord, will be personally responsible for an injury on the rented premises if it can be shown that you or your agent were somehow negligent in maintaining the property, and that the negligence in doing so was the proximate cause of the injury. Your definition of
“reasonable” will almost certainly be different from the insurance adjuster’s definition.
Most liability insurance policies will protect you from a slip and fall. That’s it. When a lawsuit comes around, your insurance company will be nowhere to be found. This is
why you need a layered asset protection strategy. A proper asset protection strategy is supported by:
● Clear, written contracts;
● Legal entities such as LLC’s, Trusts, and Corporations, that are all intelligently coordinated into a comprehensive structure; and
What I like about this bullet pointed list is that it shows how insurance is only one third of an asset protection strategy. If you’re a real estate investor and you only have
insurance, that’s the equivalent of going into battle with only one third of the ammo you need.
Asset Protection Misconception Number 2: Forming A Legal Entity Guarantees Your Protection
Yes, LLC’s, certain types of trusts and corporations do provide you with some serious legal protections. But that’s only if they are properly set up, organized, and maintained. You can’t just form an LLC and do anything you want.
For example, once you have an LLC you have to be extremely careful about not mixing your business assets with your personal assets. This is where many people go wrong. They figure that the purpose of the LLC was to hold an investment property, so it should be okay for them to start living off the rental income each month. Right? Wrong! If you have been using the business funds for personal living expenses, then when a claim arises, and the LLC’s bank account is empty, the court can disregard the LLC. The rationale is that since you didn’t treat the LLC like a separate business, then the court and the plaintiff can disregard it as well. The court can then enter a judgment against you personally.
So the moral of the story is, when using a legal entity like an LLC, be sure to keep careful records of your business related transactions, and never mix business with pleasure.
Asset Protection Misconception Number 3: An Asset Protection Strategy Can Be Put In Place Later And Still Protect You
I can’t tell you how many times I’ve received a call from a real estate investor seeking to put in place an asset protection strategy after someone’s just filed a lawsuit against them. Asset protection isn’t like a hat you can take on and off when you please, it has to be put in place well in advance of a lawsuit. This is because there are laws that
basically make transferring assets in the middle of a lawsuit illegal.
That being said, after there is a claim against you, it may be possible to take steps to protect your assets from future claims.