At Risk of Seizure by Your Creditor
If a creditor has sued you, or a court has already entered a judgment against you, the account you are probably most worried about is the one that runs your company. Business cash flow is everything for a small business. If the checking account for the business is seized, it can be disastrous. But can the creditor really get it? The answer is: It depends. It depends on how your business is structured. If it is a sole proprietorship, then there is no separation. If it is an LLC or Corporation, then there is.
If you’re a sole proprietor, the money in the business bank account is technically considered your money. There is no legal distinction between your personal and business finances, meaning the business bank account could be at risk of seizure by your creditor. In effect, your business and your personal bank accounts are the same bucket. The exposure is greatest when the business doesn’t even have its own tax ID number or federal EIN. For business owners who have formed an LLC or corporation, their business accounts are separate from their personal accounts. This separation adds a layer of protection from creditors. In most cases, the money in your business bank account is not the property of the judgment debtor, but that of the business entity. That is why a business account generally can’t be garnished for a personal judgment when the company is a separate entity with its own tax ID.
That protection has limits, though. If you treat your business funds as personal cash, moving money back and forth without clear accounting, a court may see you and the business as one and the same. If the business isn’t separate in practice, a court may “pierce the veil” and treat the owner as personally liable. Personal guarantees create the same problem. With an LLC or corporation, your business accounts are generally protected, but if those accounts are tied to personal guarantees on loans, they can be at risk.
Bank Levy
The tool creditors use to get at the money is the bank levy. A bank account levy is a legal action that allows a creditor to seize money directly from your bank account. This typically happens after a creditor has obtained a judgment against you in court. Once the creditor has that judgment, it can request the levy, and the bank is required to freeze the account to prevent any withdrawals or transfers and pay the specified amount over to the creditor. Levies are common for significant unpaid debts such as taxes, child support and judgment debts. You usually will be given notice before the account is levied, so you have time to work with the creditor or challenge the levy. However, that isn’t always the case. For a business, a bank levy cuts into the cash you have on hand, which can lead to missed payments, lost opportunities, or even business closure.
While a creditor may be able to freeze your account, they can’t necessarily take all your money. The amount of money taken will vary depending on the type of debt, your state’s laws and how much the debt is. For example, the IRS can levy up to the amount of the tax debt. State law also plays a role, and it varies from state to state. Some funds, such as Social Security, Supplemental Security Income, veterans benefits, student loan disbursements, Federal Emergency Management Agency (FEMA) assistance and federal, civil service or railroad retirement benefits, are exempt from a levy under federal law.
The best way to prevent a bank levy is to stay up to date on your obligations and communicate with creditors. Know what you owe and what happens if it goes unpaid, and if a creditor threatens legal action, take it seriously. When a legal notice or a letter from a creditor shows up, don’t throw it in the trash without at least opening it. The creditor has already taken a legal step that affects you, and ignoring it could lead to worse consequences. Respond promptly. Do some research on your rights, and consider calling a lawyer to discuss your situation.
If you are unable to pay your debts, you should try to negotiate with the creditor. A bank levy takes time and resources, so a creditor may prefer to negotiate with you before jumping to the levy. Many would rather agree to a settlement or a payment plan than go through the legal process, and often a negotiated settlement is more appealing for you as well, because it keeps money in the business on terms you can plan around.
If your debts have become truly unmanageable, bankruptcy might be an option. Filing Chapter 7 or 13 bankruptcy can stop the levy, but you have to qualify and the long-term effects are serious. Bankruptcy should be considered a last resort. It’s important to explore all of your options before deciding to file for bankruptcy.
Structure and Discipline
Longer term, protecting your cash flow comes down to structure and discipline. It can be tempting to launch a business as a sole proprietorship because you don’t have to set anything up. But forming a separate legal entity like an LLC or corporation, even as a sole owner, helps create a wall between you and your business. The safest way to protect business cash flow from creditors is to treat your business like a separate entity.
Forming the entity is only the start. You must file the correct paperwork, hold meetings and maintain records to keep your LLC protected. Failing to maintain these formalities can erode the protection the LLC gives you, leaving your personal and business assets vulnerable. The corporate veil is a legal concept that protects owners from personal liability for business debts. When a judge pierces the veil, owners lose this protection, and personal and business assets are treated as one.
Never mix business money with your personal money. Open distinct accounts for personal expenses and business transactions and use them exclusively. Mixing funds can erode the legal protection that an LLC or corporation provides. The same goes for credit cards, and every transaction between your personal and business accounts should be documented. Personal expenses shouldn’t be paid from the business account, as this mixing of funds can put both accounts at risk.
Carry enough insurance, too. Liability insurance is a way to protect business assets in certain types of lawsuits.
Finally, be careful with personal guarantees. When you sign a personal guarantee, you are promising to pay a debt or obligation personally. It’s an added layer of protection for the lender, landlord or other party. You should always question any request for a personal guarantee and make sure that you and your business understand the consequences before you sign. If one can’t be avoided, try to limit its scope and read the whole agreement.
Protecting your cash flow from creditors is a process that should begin long before a judgment is issued. But if you are already behind and worried about your account, act quickly.
