Whoever said “if it ain't broke don't fix it” was wrong. Even if you think your business is doing well - in fact especially when your business is doing well - there may be a number of things you can do to improve your business structure in order to protect your assets from creditors. To start, re-organizing your business structure so that different businesses are separated into different corporate or other legal entities may help to prevent against catastrophic losses. If each business is operated out of a separate entity, a loss in one will likely not result in a domino effect that adversely affects the total of your business. Once businesses are separated into separate legal entitles, the following strategies can also be implemented:
(a) Hold Key Assets in Different Corporations
The owner/manager’s operating company(ies) should be stocked with no more assets than reasonably necessary to carry on the business of that operating company - usually, just the customer and supplier contracts, inventory and accounts receivable. Other assets necessary to operate the business, such as real estate, equipment, and trademarks (and other intellectual property) should be held in parent or affiliate corporations and leased or licensed to the operating company(ies). In order to accomplish this, the following basic requirements should be adhered to:
- Each entity in the group, including the operating company, should have assets and activities that constitute a separate business;
- Leases and licenses of assets to the operating company should be documented, and be on reasonable commercial terms which are actually observed in practice. To have agreements in place, which are ignored, may erode the entire structure. It is also important that these agreements not expire with the passage of time;
- Lease and rental rates, and other payments, should be market value, and actually be paid, together with all applicable sales taxes and HST; and
- Separate books and accounts and separate financial statements for each of the companies should be maintained.
(b) Separate Key Liabilities in Separate Entities
Once separate entities are set up, long term liabilities going forward, most commonly leases, can be undertaken by a shell company or leasing company. The ability to obtain a lease in such an entity without personal guarantees is a function of market conditions generally, as well as a landlord’s perception of the tenant and the desirability of obtaining the tenant’s occupancy. Some landlords will not lease to a shell company without guarantees. In order to effectively separate liabilities into separate entitles, the following may be implemented:
- A sublease to document the occupancy and use of the premises by the operating company (in compliance with any restrictions on assignment and subletting in the head lease), and actual payment of rent, with HST, should be made by the operating company to the shell company;
- Instead of back-to-back leases, a small mark-up on the rent payable under the sub-lease can be mandated to establish the shell company as having a business, and is also helpful to deter any CRA consideration of the deductibility of the rent under the head lease; and
- All communications with the head landlord should be conducted by the shell company rather than the operating company.
Making these changes to your business structure may dramatically improve your defenses against creditors, but only if such changes are made at a time when the existing business is able to meet its obligations as they come due and there are no creditors knocking on the door. (See my previous article: Asset Protection – Too Little Too Late)
For more information on corporate and commercial matters, contact Samantha Chapman by phone at (416) 368-7814 or by email at email@example.com.
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