SB 405 went into effect on October 1, 2011. It strengthens the asset protections available to Nevada-based entities. The updated charging order language affects Nevada Limited Liability Companies (LLCs), Corporations and Limited Partnerships (LPs). The law changed as follows: the new language in the statute makes the charging order the exclusive remedy of a judgment creditor- including single member LLC’s and single shareholder corporations. A charging order is a remedy issued by the court giving the creditor a lien over the debtor’s interest in the entity. As such, this new language solves the problem brought forth in case law (specifically single-member LLC cases). Using the generous provisions provided by Nevada statute, many opportunities for asset protection and estate planning can be designed to maximize protection and take advantage of the charging order as the exclusive remedy, discouraging litigation and encouraging settlement.
Main Advantages of Forming Entities Post SB 405: No Equitable Remedies Allowed
Most significantly, SB 405 adds key language to the entity statues specifically stating that no other remedies may be applied. Equitable remedies have served to allow a court to evade the “charging order as the exclusive remedy” language in the past. Equitable remedies are court-granted remedies that require a party to act or refrain from performing a particular act. Under the doctrine of limited liability, a corporate entity is liable for the acts of a separate, related entity (or individual) only under extraordinary circumstances, commonly referred to as piercing the corporate veil. Federal common law typically involves a two pronged test for piercing the corporate veil: the party sought to be charged must have used its alter ego to perpetrate a fraud or have so dominated and disregarded its alter ego’s corporate form that the alter ego was actually carrying on the controlling party’s business instead of its own. In the Ninth Circuit, cases suggest (at least in California cases), that fraudulent intent in incorporation need not be shown to pierce the veil, as long as it can be shown that the separate identity of the corporation has not been respected and that respecting the corporate form would work an injustice on the litigants. The test for alter ego liability is almost identical to the veil-piercing test. Alter ego has been defined as a lack of attention to corporate formalities, commingling of assets and intertwining of operations. Alter ego requires demonstrating that the two corporations (or individual and corporation/company) functioned as a single entity. Applying this notion, the court could set aside the protection afforded by the corporation or company by ordering that the company or corporation is the owner’s “alter ego” then piercing the corporate veil by stating that the company and the individual are one in the same (and going after the other’s assets in satisfaction of the judgment). Of course, veil piercing and alter ego concepts are separate and distinct. Piercing the corporate veil allows the court to find A vicariously liable for B’s debts. By contrast, a contention that A is B’s alter ego asserts that A and B are the same entity. Liability then is not vicarious but direct. Most other forums do not specifically disallow the court from applying equitable remedies and, as such, the court would have discretion to seek piercing the corporate veil under theories such as reverse veil piercing, alter ego, constructive trust and the like. Of note is that one exception to SB 405 was made. Courts are allowed to apply the “alter ego” theory as the only equitable remedy as to corporations (not limited partnerships or LLCs). As such, Nevada LLCs and LPs continue to be a favored structure for ease of management and asset protection.
Available Opportunities for Planning
SB 405 creates numerous planning opportunities for current business owners and those looking to create entities. Citing the precedent reached in Albright, A-Z Electronics, Modanlo and Olmstead among others, many estate and business planners in the past have been hesitant to utilize single member LLCs because a Court may state that a single member LLC doesn’t enjoy the charging order as an exclusive remedy. Per SB 405, this loophole is now specifically closed by statute. Additionally, out-of-state entities may enjoy protection as well. To bolster the protection provided by a foreign entity, there are many options available:
Start Over In Nevada
A client may choose to “start from scratch”, so to speak, and re-form the company here in Nevada, dissolving the foreign entity. This may be a good choice if the assets themselves are easily transferable.
Domesticate the Foreign Entity in Nevada
If the assets are hard to transfer (or if the entity owns many types of assets), it may be easier to domesticate the entity in Nevada, taking advantage of our favorable laws. In that instance, the individual assets would not need to be transferred, making it simple to effectuate.
Form a Nevada Holding Company
This type of “hybrid” option involves forming a Nevada entity, such as an LLC, and transferring ownership of the foreign entity to the Nevada entity. As such, no individual assets would need to be moved and the companies would enjoy Nevada-based protection. This is a great choice for clients who have a number of foreign entities or existing Nevada corporations.
What do I do if I have a corporation?
LLCs and LPs have been favored over corporations by many planners because of greater creditor protection. The alter-ego theory cannot be applied against LLCs or LPs, but can be applied against a corporation. Clients who have foreign and Nevada corporations would still like to make use of the protections now available under SB 405 to increase their creditor protection. The options above can still be used, relatively easily and with minimal expense. To conclude, Nevada’s passing of SB 405 greatly enhances its creditor protection laws for Nevada LLCs, LPs and corporations by excluding all potential equitable remedies (with the exception of the alter ego remedy for corporations). It goes even further by stating that single member or single shareholder companies enjoy the limits of a charging order remedy, therefore setting our laws above and beyond the laws of the rest of the country.