small business corporate structure question - would i need liability insurance?

I’m thinking of opening a hair salon (in CA) - here is my idea - why wouldn’t this work?

I set up 1 LLC whose sole purpose is hold all the assets of the company - the furniture, the fixtures, etc. and lease it to company 2 for $1 a year.

I set up company 2 (an S corp, as I can’t get a salon license with an LLC), which operates all the business, and has the employees and all the debts, etc.

So, if someone gets hurt, or an incident occurs where I’d usually need liability insurance, I simply fold company 2, open up company 3 with the same purpose, and have company 1 lease the assets to company 3…

What’s wrong with this setup?

P.S. The point is to avoid the $1600+ a year liability insurance costs.

This is where I think one of your problem are. By having such a lease you have shown intent to just use this company to avoid liability of the other.

Also AFAIK a S-corp or a C-corp both have liability limited to the company unless there was fraud involved.

My experience would tell you to just get the insurance. Besides my feeling, and IANAL, that your scheme would not work, you’ll feel a lot better if you know that if your chandelier falls and breaks somebody’s back, you won’t be screwing them as well.

From a more practical point of view, many business entanglements, such as commercial real estate leases, often require that you carry liability insurance.

Dumb question here, but does that make the scheme illegal? Isn’t that why big companies do nothing but own a gazillion seperate corporations?

The original question is just a variation on what if I set up one corp. to own all the assets and another one to operate the business, so that when the business gets sued, they just fold.

Because you make it an LLC or LC or anything doesn’t make any difference. I have no idea why people are so sprung on these things. They’re basically just corporations with different rule re: who/ what can be them.

Is this illegal? Well, it depends on what you mean. It’s not, “you’re going to jail” illegal in most cases. (might be w. those new laws they’ve got going now). Will it do what you want it to? Absolutely not.

The court may “pierce the corporate veil” :eek: and nullify the corporation.

Piercing can occur horizontally (corp to corp) or vertically (corp to owners). Either way, you’re not going to get away without paying your creditors. The original situation is EXACTLY the kind of case a court would do such a thing. There would be two legal entities acting as one to perpetuate, what is essentially, fraud.

Further, you might be worse off because your own assets may be on the line, whereas if you’d played the game properly, they wouldn’t be.

TOM

The foregoing is not legal advice as I am a law student and do not represent myself to be a lawyer at all. :slight_smile:

What Tommygun said.

Your scenario is the classic example a situation where “piercing the corporate veil is appropriate.”

You might be able to get away with having a separate corporation to hold the assets. (Corporation “A”). But when you fold up Corporation “B” and open Corporation “C,” most courts won’t hesitate for a second to hold Corporation C liable for all the obligations of Corporation B.

Further, many courts will pierce the corporate veil (to reach the owners) if the corporation is undercapitalized or if the corporation doesn’t carry adequate liability insurance.

Also, as an owner, you CAN get in trouble if you don’t carry adequate workman’s compensation insurance.

Also, whatever agency licenses hair salons might have insurance requirements; you personally might get in trouble with them if you the idea you proposed.

Bottom line - it’s unlikely to work.

(Standard disclaimer about legal advice)

Now, I have an LLC. My partner and I decided on it for 2 reasons:

  1. Gives an additional air of legitimacy to our still-young business-- which cost us money for the first 2 years and has made small profits the last 2–and further justify our tax deductions to the IRS

  2. To give our personal assets a layer of protection in case we are sued (we do creative work, including some writing, and worried that someone might sue us for libel/defamation of character if they objected to what we wrote about them in our nonfiction books).

So … is number 2 a total fantasy? Do we have zero protection against such attacks? Likewise if we, say, botch a web or print design job and the client sues us to recover thousands of dollars in lost revenue, etc.? (We’re not carrying any debts–the main reason we’re growing slowly–and aren’t yet relying on the business as a primary source of income, so we aren’t worried about anything other than lawsuits, really.)

One of the problems with trying to limit liability is that you never know if it is going to work until you get sued. One of the biggest expenses insurance company’s have is not the payment for injuries but the litigation expenses.

When you buy a policy an insurance company agrees to defend you in frivolous lawsuits when you are not liable. They also settle claims where you are liable.
But let’s consider one scenario, you or one of your employees blinds a 10 year old girl with some caustic hair chemical,

Are you the kind of person who will take responsibility and give the one thing you can, which is your insurance money?

Or will you say “screw you, sue me, you cant get anything and I will be open in a week”.

I would pay the $1600. If a person can’t afford the cost of doing business they should not open one.

Generally speaking, incorporating will give you a decent measure of protection against trade partners. Since trade partners enter a relationship with the corporation voluntarily, the reasoning is that the trade partner had an opportunity to asess the risks. (Note that none of this applies if you fraudulently convey away assets of the corporation, including goodwill).

Courts are more willing to let tort claimants pierce the corporate veil, particularly when the corporation should have been carrying insurance. I’m not sure about a defamation claim. (Note however that the individual officer who committed the defamation may face personal liability in any event.)

As far as consequential damages for you screwing up a design job, well, you really should have a limitation of liability clause in your contracts. You might want to see a lawyer on this point. Either that, or look at the contracts used by companies who face potentially huge consequential damages, such as FEDEX. (If you are in NY, USA or NJ, USA, feel free to drop me an email.)

(Standard disclaimer about legal advice)

Just a question for toadspittle: Why did you go with an LLC? It sounds like the tax benefits you receive from an LLC you could have also gotten from incorporating and choosing sub chapter S status.

In Illinois, the fees one pays to incorporate are significantly less than to elect LLC status.

The LLC is, in my not giving legal advice to anyone for any reason what so ever opinion, an alternative when you cannot elect subchapter S status.

(An S corporation can only have up to 75 shareholders and those shareholders must be either individuals, estates or certain qualified trusts. Non resident aliens may not own stock in an S corporation, nor may an S corporation be a subsidiary of a standard corporation (“C corporation”). An S corporation is also not permitted to issue multiple classes of stocks or own more than 80% of stock in another corporation.)

It doesn’t sound like your business would run into any of those restrictions any time soon.

Maybe in my short years I have just missed the LLC band wagon.

TOM

The main lure of the LLC was that its really, really, really easy to set up and operate. I have to file one piece of paper a year. I have to provide a 1065 to the IRS and the state. I pay $325 a year in fees. And I don’t have to go through the formalities of issuing stock, etc. And, should we someday add a third partner (or have part of our company bought out by another company), we pretty much just need to send the state a letter to change ownership percentages.

Corporation tax can be under $100.00 a year depending on how much your business makes

I think $325.00 is a lot, considering, but given the easy of use, etc., it may be a good option if you don’t have an atty, or your company would be paying more in corporate tax.

TOM