Nevada Corporations: Do They Live Up To Their Reputation?

California business lawyers and California promoters claimed Nevada corporations provide great asset protection benefits. Until this year, these asset protection claims (some of which I have heard from Los Angeles business transaction attorneys I know) regarding Nevada corporations were far from the truth, unfortunately. On July 1, 2007, all of this changed. Under a new Nevada statute, for any corporation that has two to seventy-five shareholders, the statute provides that a creditor’s sole remedy is a “charging order.”

Before SB 252, some proponents of Nevada corporations alleged that since shareholder information is not public and Nevada does not report to other states, that a creditor is less likely to discover your assets through an asset search with a Nevada corporation.

It is true that, if title is not in your individual name, a Nevada corporation or any revocable trust for that matter provide at least a small degree of asset protection. However, almost all creditors proceed to discovery regardless of whether an initial asset review revealed a debtor’s assets. During discovery, you will truthfully disclose your ownership interest in a Nevada Corporation or revocable trust.

Why Is There No Asset Protection Provided By A Corporation?

Typically, a shareholder has the following three rights regarding corporate stock:

Right to share in the liquidation proceeds;

Right to vote the directors of the corporation; and

Right to share in the profits (i.e., dividends).

When a creditor attaches the shares of a corporation, the creditor stands in the shoes of the client/debtor and receives all three rights.

If the creditor attaches to more than a majority vote, which is usually 50%, then the creditor votes itself as the director(s), and the creditor/directors vote to liquidate the corporation and distribute all of the assets to the creditor/shareholder. Consequently, unless you owned less than 50% of the stock, there was almost no asset protection with an offshore corporation, a Nevada corporation, or any corporation for that matter.

What’s Charging Order Protection?

Generally, a charging order may be defined as a right to a distribution, when and if ever made. With a charging order, a creditor is left with a right to distributions when made – but the creditor has no method (e.g., voting rights) to force a distribution.

Partnership law (and subsequently LLC law) developed differently than corporate law. Rather than allowing a creditor to attach all of the rights of a partnership interest, a charging order allows a creditor only to attach a right to distributions. The creditor does not receive any voting rights.

So if a charging order is the sole remedy of the creditor, the result is having to wait, with the question being who can wait the longest – you or the creditor? If you can out-wait the creditor, typically the creditor will settle for less than the judgment amount.

The Nevada corporate charging order statute provides that for the first time, corporate stock may now be protected by a charging order.

However, there are some limitations. Remember that the following are not protected under SB 242:

professional corporations
single owner corporate stock
corporations that have seventy-five or more shareholders

Outside of Nevada, there is always the question of whether an out of state judge will apply Nevada’s new law.

However, at a minimum, forum shopping for favorable sole remedy charging order protection at least presents a legal hurdle for a creditor to surmount at a fairly inexpensive cost.

Is A Charging Order The Sole Remedy Of A Creditor?

Generally, the answer is no. A charging order is not a creditor’s only right. California follows the trend and allows the judicial foreclosure sale of the limited partnership interest.

Nevada’s Sole Remedy Statute

Similar to certain states that have provided sole remedy charging order by statute to family limited partnerships (FLPs) and limited liability companies (LLCs), Nevada is the first state as well as the first nation to provide charging order protection for corporate shares of stock.

SB 242 Section 43.5 states:

“On application to a court of competent jurisdiction by a judgment creditor of a stockholder, the court may charge the stockholder’s stock with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of the stockholder’s stock.
This section:
(a) Applies only to a corporation that:

(1) Has more than 1 but fewer than 75 stockholders of record at any time.
(2) Is not a subsidiary of a publicly traded corporation, either in whole or in part.
(3) Is not a professional corporation, as defined in NRS 89.020.

(b) Does not apply to any liability of a stockholder that exists as the result of an action filed before July 1, 2007.

(c) Provides the exclusive remedy by which a judgment creditor of a stockholder or an assignee of a stockholder may satisfy a judgment out of the 5 stockholder’s stock of the corporation.

(d) Does not deprive any stockholder of the benefit of any exemption applicable to the stockholder’s stock.

(e) Does not supersede any private agreement between a stockholder and a creditor.”

Conflict Of Law Issues:

For those of us who do not live in Nevada, may we forum shop and come under Nevada’s new charging order protection for a closely held corporation? Some might say at first, “Of course you can.” Conflicts of law cases strongly support that the place of incorporation governs shareholder rights.

An analogous issue is discussed in legal circles regarding whether a person who does not live in a Domestic Asset Protection Trust (“DAPT”) state (e.g., someone who lives in California) settles a trust in a DAPT state (e.g., Nevada). Will the California court apply California law or will a California court apply the governing law of Nevada as stated in the trust?

When making this decision, a court may apply any one or combination of the following factors:

(1) the situs of the trustee;

(2) the residence of the beneficiary;

(3) the situs of the trust property;

(4) the residence of the settlor;

(5) the choice of law designated in the trust;

(6) any other factor.

With a trust, by moving all of the trust assets to the DAPT state and not using an out of state trustee, the first three of the five specific factors may be weighted in favor of Nevada law. This might be enough evidence for a California court to hold that Nevada law governs the DAPT under conflict of law principles.

Unfortunately, it is harder to get a majority of the factors in favor of a FLP, corporation, or LLC.

Regrettably, clients forum shopping for FLPs and LLCs generally hold the underlying partnership assets or LLC assets outside of the state of organization. Further, there is no forum state trustee with an FLP, LLC, or a corporation, and the client usually demands to hold the position of general partner, manager, or president. If this is the case, only one of the four specific factors is in favor of applying Nevada law, and whether a California court will apply Nevada law for a creditor claim is highly uncertain.

To improve the odds of applying Nevada law, consider holding a significant portion of the assets of the FLP’s, LLC’s, or now Nevada Corporation’s in the sole remedy state.

Cost-Benefit Issues

Even if forum shopping proves not to be successful, what is the cost/benefit to present this legal hurdle to a creditor? Annual costs are relatively small compared with the possible benefits of a court applying the law of the forum jurisdiction. Generally, those costs include the annual cost of the registered agent and sometimes there are dual annual filing fees for the entity: one in Nevada in the above example and the other in California. If the cost is only the registered agent, the cost/benefit amount is typically from $250 to $350 a year. If there is a dual annual filing fee, the incremental cost is typically from $50 to $100 a year.

To discuss these and other business transactions, call Mitchell A. Port at (310) 559-5259.