Unfortunately, many clients that come into my office come in after judgments have been entered against them or foreclosure proceedings have begun. At that point, it is often too late for any asset protection planning, which is best done before trouble arises. Asset protection planning that takes place so late in the game raises presumptions of “actual fraud” under UFTA. If the client involved is a small business owner, it also presents another problem: a breach of fiduciary duty by the officers of the company.
The normal rule in business law is that the officers and directors of a corporation (or managers of an LLC) owe a fiduciary duty to the shareholders of the corporation (or members of the LLC). In a nutshell, this means that the actions taken by the officers, directors, or managers must be made in the best interests of the company itself in order to maximize return for the owners of the company. Management is not permitted to make decisions to enrich itself to the detriment of the company’s owners. In a simple example, assume the CEO of XYZ Corp enters XYZ into a contract with ABC Corp. Assume the CEO of XYZ is also a shareholder in ABC, and that the contract is unfavorable for XYZ but beneficial to ABC. In this example, the CEO has breached his fiduciary duty to the owners of XYZ, and may end up getting sued personally.
In New Jersey and many other states, this normal rule is turned on its head when a company becomes insolvent. [A company is insolvent when its debts are greater than its assets.] Once a company is insolvent, the fiduciary duty of the officers, directors, and managers switches from the owners of the company to the company’s creditors. Whitfield v. Kern, 122 N.J. Eq. 332, 340-342 (E & A 1937); Portage Insulated Pipe Co. v. Costanzo, 114 N.J. Super. 164, 166 (1971). In a nutshell, this means that if you are a small business owner/manager and your business goes south, while you are not required to contribute more of your personal assets into the business, you do have a duty to preserve whatever assets remain in the business for the benefit of the business’ creditors. You cannot transfer assets out of the business to yourself to avoid collection by creditors. Such an action is a breach of your fiduciary duty to creditors, and opens you up to a lawsuit by a creditor. Such a lawsuit could lead to personal liability on the business’ debts.
The lesson here is to start planning before things get bad. As always, if you have any questions, feel free to contact me.
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