Episode 22: Avoiding Lawsuits in Business & Investing

Announcer: This is The WealthAbility™ Show with Tom Wheelwright way more money, way less taxes.

Tom Wheelwright: Welcome to The WealthAbility™ Show where we’re always learning how to make way more money and pay way less taxes. Hi, this is Tom Wheelwright your host, founder and CEO of WealthAbility™. What if you could form your business or set up your investments in such a way to give you maximum protection from ever even getting a lawsuit? That’s what we’re going to talk about today. I have a very special guest with me, one of my very, very good friends and we’re going to discuss how to avoid a lawsuit because it’s not just about winning a lawsuit. We want to avoid the lawsuit.

Well, a few years ago, I had a personal experience. Okay. I ended up in a lawsuit with a former partner and we thought, my other partner and I, we thought we had this iron clad contract and we actually went in, the judge had us do mediation right off the bat. And I asked the mediator. I said, “What’s our chance of winning?” He says, “Well, 80, 90% chance.” “Great.” They didn’t offer very much. We went into the lawsuit. We lost. Because what happens is, is that it’s not you, it’s not the law always that matters. What matters is the judge or the jury, I mean. And my guest I’m going to introduce now is really a specialist in this area. And I’d love to have him share his thoughts on this. My guest is Garrett Sutton. He’s the Rich Dad Advisor for asset protection. My favorite book of Garrett’s is Start Your Own Corporation. Garrett, welcome to the show.

Garrett Sutton: Thanks, Tom. Pleasure to be with you and your audience.

Tom Wheelwright: So Garrett have you seen this before? I mean, tell me that I’m the only person that’s ever lost a lawsuit because the judge didn’t like my position rather than the law.

Garrett Sutton: Tom, that is a very common experience. You have the law and you have the black letter law, the certainty there, but there is room for the judge to rule against you for personal reasons, for other reasons that you may never know. And the same is true with the jury. If you go before a jury of 12 citizens, they may not like the way you wear your shirts or your ties. I mean, they could come down to something as insignificant as that. We really don’t want to get into the legal system when we play that game, Tom, that piercing the corporate veil game, we don’t want to go to court. We want to stay out of court.

Tom Wheelwright: That’s what I learned. I mean that was kind of the hard lesson there. It was financially, it was a lot of money. In the total, it costs me about half a million dollars and the reality is we could have settled up front and it would have cost me $100,000. And yet still what it costs me money and it was wrong. But at the same time, the challenge is, is that you don’t know a judge’s leanings. In this case, it came down to I had money they didn’t, and the judge felt like they should. Garrett, you and I’ve seen that with clients in lawsuits, especially with juries, right?

Garrett Sutton: Absolutely. And, Tom, we also need to recognize that the attorneys on each side have an economic incentive for this case to move forward. We don’t like to talk about it, but that economic incentive does exist. And as a client, you need to maybe dig in your heels a little bit and slow things down and figure out a way to try, and settle this because once you walk into a courtroom, whether it be a judge deciding your case or a jury, everything is cast to the wind. You do not have any certainty of how it’s going to turn out. So we want to stay out of court. If we get into court, we want to figure out ways to settle the case if possible so that you can move on with your lives. Litigation is very stressful. It saps not only time and money but your energy. And so if there’s a way to stay out of court, I always recommend it.

Tom Wheelwright: It’s interesting, Garrett, you and I travel a lot together and you’ve got this great game. What’s always fascinating is we play this game and you give the same situation to 10 different groups, and they’re coming up with and they’re presenting their case and they’re presenting their arguments and you’ve got a judge on the other side and it seems like it’s about 50/50 on who wins, right? Plaintiff or defendant.

Garrett Sutton: We’ve never had a case where we played this game, Tom, on four continents and we’ve never had a case where the fact pattern went exactly one way. There was always a difference in opinion between the judges selected for each team on the outcome of the case. That’s the lesson is you just don’t have the certainty when you walk into court that you’re going to win.

Tom Wheelwright: So that brings me to, I know one of your favorite topics and one of mine, and that is so is insurance enough? I mean clearly, everybody needs to have liability insurance, umbrella policy et cetera. That insurance is very important. What’s the difference between insurance using insurance to protect you and using entities to protect you?

Garrett: Well, insurance is the first line of defense, Tom. I always recommend that people have insurance. You’re going to have insurance on your buildings, on your business. You mentioned an umbrella policy whereby your home and auto are insured with the same company and you can get an extra million dollars of insurance coverage for less than $400 a year. So I always recommend having insurance. But again, let’s talk about economic incentives. The insurance companies have an economic incentive to not settle every claim. So they figure out ways to deny coverage. That’s part of the insurance game. And there’s a whole area of law called bad faith litigation whereby people have to sue the insurance company to honor the commitment. They paid the premiums, now it’s time for the insurance company to pony up for any damages.

So it’s not a certainty that your insurance company is going to cover you. So you need that second line of defense, which are the entities, the corporations, the LLCs, maybe a limited partnership to protect you in the event that your insurance company does not cover you or maybe there’s not enough coverage for the claim, so you want to have these entities in place as a second line of defense.

Tom Wheelwright: And again, so I’m curious, I get this question a lot, Garrett, does having umbrella policy insurance, does it prevent a lawsuit, or if you have a really big policy, does it actually encourage it?

Garrett Sutton: Let’s talk about it. So you would have an umbrella policy for your personal activities. And the biggest risk is you’re going to get in a car wreck. The umbrella policy will add a million to three million, however much you buy, to cover any claim that’s brought against you by a car wreck victim. Now, by having that pot of insurance money, the attorneys know how to get at the insurance money. Then we have all your other personal assets, your duplex, your brokerage account, whatever else in LLCs. And if we do it right and we use Nevada or Wyoming LLCs, it’s very difficult for the attorneys to get at those assets. It’s something where they don’t want to wait around and have to hire an attorney in Wyoming to go after these assets.

In my opinion, if you have enough insurance for the attorneys to get at, they know how to get at it and you have all of your other assets protected by the correct LLCs that we set up, then the attorneys are less likely to go after your personal assets. It’s not a winning bet for them. They have to wait around. They have to spend more time and energy to collect that money. Most attorneys are economic animals. They’ll go to the next case which has plenty of insurance money. And so that’s how we structure the affairs of clients.

Tom Wheelwright: Now, that makes sense. One of the things I do love about the umbrella policy is that, to me, the most important thing you get with an umbrella policy, with the insurance is not the coverage, actually, it’s the insurance companies have really good attorneys. They have a strong reason to fight this. And I’ve actually had some really good experiences with having the insurance company handle the claim. In fact, the first lawsuit I was ever in, we happened to have coverage, was a really odd situation that we even had coverage I think. But we had coverage. It was another partner. There’s a theme here. It was an another partner and this was years and years ago.

But the insurance company handled all of the legal fees and they brought in their attorney. And to me, that’s a really big part of the insurance. But let’s move on to … Okay, so you’re going to form entities and we’ll get into which entities to form. It’s pretty easy to form an entity online. I know that you have particular views about this. Here’s your softball question, is it better to use an attorney or to just do it yourself?

Garrett Sutton: Well, Tom, the softball question I’m going to knock it out of the park. I mean, it’s always better to use an attorney who knows what your situation is. An online service doesn’t really know what your situation is. Are you investing in real estate? Are you starting a business? How should you be taxed? Tom, that’s a huge question in all of this. So I like having the attorney and the CPA work together and come up with the best structure for our clients. I’ve got to tell you, Tom, I see some of these online services and what they provide and you’ll get the articles of organization for the LLC but that’s it. Well, you’re only 30% of the way done. You have to do an operating agreement, you have to do minutes of the meeting.

You also have to have the membership interest or the stock certificates issued. If the IRS comes calling and you don’t have those issued, and most online services don’t do that for you. You’ve got two strikes against you, so you want to do everything properly at the start. Really when you compare apples to apples, Tom, between some of these online services and the charge we charge at Corporate Direct, it’s about the same. You’re not saving that much money by doing it online when you add up all the extra fees that they tack on. They have a $99 come on but by the time you’re done, they’re charging you $800. So I think it’s always best to use an attorney and a CPA when you’re getting started in business or real estate investing.

Tom Wheelwright: Any reason not just to have the CPA do it?

Garrett Sutton: Well, Tom, I like to say that CPA stands for cannot protect assets. Some CPAs think they can do all this, but I think you need an experienced attorney who knows some of the subtle variations between these entities from a legal standpoint to give you that type of advice.

Tom Wheelwright: I agree, actually, it really disturbs me when I hear people say, “Well, my CPA says I don’t need this entity or I don’t need that entity for asset protection because of this, this, this.” And I’m going to me that’s malpractice. That’s the unauthorized practice of law because the CPA does not have a license to practice law other than tax law. So if they’re saying that you don’t need to do it, just understand that is absolutely, in my mind, malpractice and they have no business doing that. Just like I don’t think a financial planner has any business telling you how to handle your taxes. It is important to get the right person on your team to do the right part of it. Okay. But let’s talk about what those parts are. You talked a lot about LLCs this morning and people hear that term LLCs. First of all, what is an LLC and what’s the difference between an LLC or a corporation from a legal standpoint?

Garrett Sutton: Good question. So the LLC stands for Limited Liability Company and they started in Germany in the late 1800s and spread around the world. And these Wyoming wildcatters discovered them in the 1970s and they were able to get convinced the Wyoming Legislature … They convinced the Wyoming Legislature to set up an LLC law and it was so popular that it spread to all 50 stat. And the LLC offers great asset protection via the charging order and I don’t know if I’ll have time to discuss that, but that’s the main feature that the LLC offers. The LLC has flexibility in taxation and, Tom, I’m sure you talk about that, how an LLC can be taxed as a C Corp, and S Corp, however you want. And the LLC in many states offers privacy. They don’t list your name on the state website as being an owner.

So the LLC has a lot of advantages. The corporation started in the 1500s in England and it’s been around for much longer than the LLC but the corporation doesn’t provide the asset protection when you get sued from the outside. Meaning if you get sued in a car wreck and the wreck has nothing to do with your business inside the corporation, but someone who has a claim against you. With a corporation in 49 states, except for Nevada, with a corporation, someone can sue you personally and attach your shares and gain control of the corporation. So that’s why people, gosh, Tom, 95% of the time people are using LLCs because you have much better protection from an outside attack, especially with Wyoming, Nevada, and Delaware.

Tom Wheelwright: Explain that for a second because that’s the charging order that you’re talking about. Just briefly explain what that charging order does and doesn’t do and what it takes to make sure you get protection of that charging order.

Garrett Sutton: The charging order is a lien on distributions. Meaning the person in the car wreck would love to get at the real estate inside the LLC, but in a strong state with the charging order, all they get is what’s distributed from the LLC. They can’t barge into the LLC and force a sale of the duplex or the other real estate assets. Now, that’s in a strong state. There are a number of weak states whereby the court says, “Sure, you were in the car wreck, go ahead and sell the duplex inside the LLC.” That would be California, Utah, New York. Some are weak states. So we want to use Nevada, Wyoming and Delaware, which feature the charging order as a exclusive remedy. So that’s where the charging order comes in and that’s why it’s important and you wouldn’t necessarily know with an online service to pick the right state to set up your LLC in.

Tom Wheelwright: Thanks for that. So let’s talk a little bit because our offices work very closely together. Let’s talk about the coordination between tax strategy and legal strategy. I always look at it as the tax strategist. The tax advisor is really the architect and the attorney is the builder. Garrett, when we work together we’ll typically come up with what we think the entity structure should be from a tax standpoint. I mean, I’ve been traveling with you long enough, Garrett, that I was teasing before we started recording, I was teasing him that I could be Garrett.

I don’t know if I can do his voice, but I’ve heard it so many times. And that’s important because what it means is, is that we’re going to do our best to set up the entities in such a way that will protect you from a tax standpoint, and we think is probably okay from an asset protection standpoint. But we always caveat that and say, “Okay, look, here’s what we’re recommending. Next step is to take this to an attorney and let the attorney look at it and say, ‘Okay, this looks right,’ or, ‘No, I’d like to make a couple of changes.'” I mean, does that make sense to you, Garret?

Garrett Sutton: Yeah, absolutely, and, Tom, your group is really good at creating a visual chart of what the structure looks like and then I’ll get on the line with the CPAs and we’ll look at that structure and make a couple changes if needed. I mean your team’s pretty darn good, but there are state laws change. We keep up on the various changes across the country and so we’ll make a tweak here and there. And then we work together. It’s a team effort. So we have the CPA is the architect, the attorney completes the foundation and it’s all to the benefit of the client.

Tom Wheelwright: Are there other asset protection techniques that you like? I mean, are there other things that we can do?

Garrett Sutton: Well, we always liked for our clients to have a living trust so they can avoid probate. We work with estate planning attorneys and you would have the LLCs be owned by the living trust. It’s important to realize that the LLC does not offer estate planning opportunities. It doesn’t avoid probate. The living trust, while it does avoid probate, does not provide any asset protection. There are a lot of promoters out there that say a living trust provides asset protection. That is incorrect. So we use them together. They dovetail. The LLC provides the asset protection for your real estate and business assets. The living trust owns the LLC and provides the probate avoidance and the estate planning opportunities.

Tom Wheelwright: I love that structure. I’m with you, Garret, I use that with I think every client. There are a lot of attorneys who say, “No, probate’s easy now. You really don’t need a living trust.” But what I like about a living trust is from a very practical standpoint. What I like is, obviously, it doesn’t add any asset protection because it’s revocable because you can change it at your will. Okay? That’s why there’s no asset protection. On the other hand, what I like is you know you and your children, your heirs and know exactly what’s going to happen when you die. My experience with survivors, you know they’re the heirs to the estate.

When somebody dies, my experience is that it just makes life easy. I had a client years ago, one of my dear … He became one of my dear friends, he and his wife and he was a doctor and he passed away. She was much younger than him and she came to me and said, “What do I do?” And I said, “Well, let’s sit down with an attorney.” And so we did. I said, “So what are we doing?” And the attorney says, “Nothing.” It was all set up. The doctor set it up just right. He transferred all the LLCs, the assets. He transferred them into the trust. He did everything correctly and he goes, “You’re good to go.” I mean, there was literally nothing else to do,

Garrett Sutton: Right. And that’s what you want. And anybody who tells you probate is easy and inexpensive is not giving you the accurate scoop. Probate is time-consuming. It’s a matter of public record. The attorneys have specified fees. The attorneys make out really well when they have to probate an estate. For example, the living trust may cost you 2,000, $3,000 to set up during your lifetime. Probate is going to cost your heirs 20 to $30,000 in attorney’s fees if you have to go to court and do the administration. So the living trust is definitely the way to go.

Tom Wheelwright: Yeah. So I think the theme here is that the winner in anytime that you’re in court, the true winners are the attorneys.

Garrett Sutton: That’s true. We take pride in helping people stay out of the court system and, through the living trust, through the corporations and maintaining the corporations and LLCs, Tom, because you can have the veil pierced if you don’t follow the formalities on an ongoing basis. You’ll find yourself back in court if you don’t follow the corporate formalities. But if you follow these things and they’re not hard to do, but If you follow them and follow the corporate formalities in the right way, you’re going to stay out of court.

Tom Wheelwright: Again, remember, the goal here is to stay out of court. I mean, that is the goal is to not get sued in the first place. I always draw the picture in my mind, okay, if I’ve got on my house, I have an alarm system and I’ve got locks on my doors and alarms on my windows. I’ve got a guard dog, which I have a big, big guard dog just so everybody knows really, really, really, I mean, she’s a giant, giant dog that will scare the death out of anybody. But if I’ve got those things that’s not going to necessarily absolutely prevent a burglar from coming in. But if I’ve got that and my neighbors don’t, the burglars are just going to go to the neighbors.

What I like about this is the whole goal here … It’s like the old story about if you’re out in the woods with a buddy and a bear starts chasing, you don’t have to outrun the bear, you just have to outrun your buddy, right? And the truth is that that’s kind of the way it works with lawyers because knowing that lawyers are going to go after easy targets first. What we want is we just want to make you the toughest target possible to avoid the lawsuit because when you avoid the lawsuit that’s when you save the money. So, Garrett, give us where, how can our listeners get in touch with you?

Garrett Sutton: Well, our main website, Tom, is corporatedirect.com and they can also call for a free 15-minute consultation with one of our paralegals to see if we can help you and find out what the costs are and everything. And that number is 800-600-1760. So corporatedirect.com or 800-600-1760 is the best way to get in touch with us.

Tom Wheelwright: Awesome. And thank you, Garrett. Just remember everyone that we’re trying to do is we’re trying to reduce our expenses, protect ourselves because when we do that, not only do we make a lot more money, we end up with a lot more money because we don’t have all those costs, but we all also at the same time, paying a lot less taxes.

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