Shell Corporations - Liability

It occurred to me some time ago that starting multiple businesses opened me up for something I was not interested in, liability. For every new business I start, I have to take out a new line of insurance for general liability and/or workman’s compensation coverage. Obviously this gets expensive, but it is necessary.

With each new venture, I open myself up to new risks and new rewards. I needed some way to insulate myself from the risk, and at the same time, limit my tax liability. I met with a few advisors and eventually decided to setup what only the oil industry could pioneer; shell corporations.

Let me explain the idea of a shell corporation. You and your business partner(s) want to begin a business, but you would like to protect yourself from liability should things go wrong. You begin by setting up a Partnership between your business, and a second company (usually an LLC which we will call Parent). At first, you probably think Parent will be owned by you, but it won’t be. Instead Parent will be owned 99% by another LLC (called Grandparent in our example) who will be the General Partner. Keep in mind the General Partner holds all the liability for bad decisions and what not. The other 1% will be owned by you, but you are a Limited Partner, meaning you have little to no liability.

Now let’s take a liability situation and see what happens. You start a construction business and one of your workers cuts his arm off. This is bad (obviously for the worker) because you are liable. Furthermore, you made a bad decision and didn’t carry liability insurance, and the worker is suing you for negligence. Since your construction company is in a partnership with Parent (who is the General Partner), Parent is liable. However, Parent has virtually no assets and is itself in a partnership with two other entities, Grandparent and you. Since you are a limited partner and Grandparent is the General Partner, Grandparent has to take responsibility. Grandparent takes the fall, and of course has no money. So you abolish Grandparent, and form Grandparent (2). Since you are the Limited Partner, you are safe from liability.

Obviously there are ways around this example, but it costs a lot of money to navigate the legal waters. Ethically, you have to feel bad for the guy who cut his arm off, which is why most clients will refuse to give you work unless you carry liability and workman’s comp insurance.

The moral of the story: If you are going to work for someone, make sure they have insurance (and more importantly care about their workers). And if you are the employer, take care of your people; they can be your biggest asset, or your biggest liability.

For my next post, I will talk about how you, as the 1% owner still get paid, and limit your tax liability.

-CR