Doing Business with Family is Risky

March 28, 2017

Without asset protection, physicians face a litany of risks in both their personal and professional lives.

Asset protection for physicians can take many forms, this recent case shows how widely the exposures and required solutions can vary. Physicians should always have asset protection in place to prevent situations like the one below from becoming a reality.  

Doing Business with Friends and Family is still "Doing Business"

I recently spoke with a successful physician (for the sake of confidentiality, I'll refer to her as Rachel) that, like many other doctors, has used her practice generated savings to invest in other projects like real estate and medical lab businesses. Some of the projects involve third party partners that she is not related to, while others involve her own family members. Several of these projects have successfully run their course, producing significant revenue for all the partners as planned, while others continue to produce a significant income stream for each partner.

Unfortunately, the projects with family members were partially handled on a handshake and trust based on past deals and were not as well legally documented as the deals with non-related partners. Despite the fact that Rachel has made her relatives over $400,000 in short-term profit on two previous deals, their unrelated personal relationship issues have created a wedge in their business dealings. Rachel faces significant legal exposure and defense costs because her family has made a number of baseless and retaliatory claims against her including fraud. They have also attempted to convert assets and income from other jointly owned investments into their separate property without her knowledge or permission. Like most people in this position, Rachel is shocked that they would be so vindictive and, in her view, dishonest and vicious in their claims. This has caused her significant emotional stress in addition to the legal risk and serious defense costs.

Problems Rachel faces:

•She has significant non-related assets and income streams that are now exposed to her family's claim, including her hard-earned practice income.

•As she now has actual notice of the current claim, she cannot implement asset protection planning (that she should have done long ago) to protect her other assets and income streams against this problem as it would be a fraudulent conveyance or voidable transaction.

•The deals with third parties Rachel is part of were well documented by their respective lawyers who had created the appropriate legal entities to hold the properties, like LLCs. They also had detailed operating agreements, chains of command and banking structures in place that provided transparency and protection to everyone involved.

•In contrast, Rachel's deals with family had LLCs set up but no formal operating agreements beyond a verbal understanding that they were 50/50 partners and shared the assets and liabilities. The missing documentation would have controlled who did what, how profits were expected to be divided, operational responsibilities, and conflict resolution procedures, including the desired sale or exit by a partner. Now, all of that will be decided at the discretion of the courts, subject to litigation, and will generate significant additional expenses and an unknown result. Because Rachel and her family members have multiple businesses set up in this informal way (that worked until it didn’t) she has significant risks and financial issues. Now she has to spend money on lawyers to defend herself against their claims and to preserve her rights in the other properties and assets that she's a co-owner of. Rachel has this additional expense at a time when the other party is withholding her income from other projects, a bad combination.

•Part of a comprehensive business plan for these ventures should also have included D&O (director and officer's coverage) insurance, which would have protected the partners, including Rachel, from litigation expenses related to their service and ownership. Many business people think this is only for outside claims, but, it also protects entrepreneurs against intra-company lawsuits between partners, and should be part of your medical practice's core insurance coverage. In this case, having someone else (the insurance company) to pay those bills would have gone a long way.

Many families do business together successfully, observing the basic good practices and legal formalities required of any business deal. If utilized, these good practices protect both your wealth and your relationships.

*Non-material identifying details have been changed to preserve client confidentiality