Limited Liability Companies (LLC’s) may protect assets from the claims of outside creditors, but this protection depends on the law of the state in which the LLC was organized or the law of the state of business, depending on where the obligation was created. This protection is not fool proof, hence the word “limited.”
There is a healthy, justified debate over the states’ statutes that provide the best protection. In general, you should note that it is beneficial, from a protection point of view, to compartmentalize your assets. This is why many people choose LLC’s as shells, if you will, for their assets. In many ways liability is like water, it seeks its own level; in the case of liability, it seeks the weak vulnerable assets and flows in that direction.
States also vary in cost and taxation. We feel that first-rate protection of your business trumps saving the few dollars of extra taxation that you may be required to pay. For this purpose, we discuss protection. What are the corporate laws of the state regarding the rights of creditors?
If you incorporate in one state and end up conducting most of your business in a different state, you will have to qualify to do business in that other state, which will involve more fees and costs, more filing requirements, and more paperwork. If your business actually conducts business in more than one state, or if it is a large, publicly held corporation, it can be worth the additional cost and time to incorporate in one state but operate in another state or states. A corporation doing business in a state other than its state of incorporation is considered a foreign corporation.
The greatest disadvantage is that a corporation may have to defend itself in another state, but not always. There may be clauses added to contracts that specifically outline the remedy process, and you may designate where you choose to remedy any claims providing that the clause is legal.
Common sense comes first. In most cases, it is best to incorporate in the state of business. What then is the buzz about Delaware , Nevada , Alaska, Wyoming, New Mexico, and several other Debtor friendly states?
Over sixty percent of the Fortune 500 Companies and half of publicly traded companies have incorporated in Delaware. The United States Chamber of Commerce Institute for Legal Reform has ranked Delaware as the top state to incorporate in for six consecutive years (Harris Poll State Liability Ranking 2006).
The Delaware Court of Chancery hears mostly cases concerning equity and uses judges instead of juries. Delaware law does not require the names of the board members to be public. Only during legal proceedings or court matters must this information be revealed.
Most states allow a creditor of an LLC member to foreclose on the debtor’s interest. This should be compared to the states of Nevada and Alaska, which provide that a creditor’s only remedy is a charging order against the LLC interest.
However, it should be noted that, according to an attorney from a southern state, benefits from state laws making a charging order the exclusive remedy may be overstated. Even if a creditor can foreclose on a debtor’s LLC interest, the creditor is unlikely to do so because a purchaser at a foreclosure sale obtains no management or voting rights. In addition, a purchaser at a foreclosure sale is more likely than the holder of the charging order to suffer adverse income tax consequences.
A west coast attorney agrees that a creditor may be worse off as the assignee or owner of an LLC interest than as the mere holder of a charging order. While an attorney in the southwest feels that availability of the foreclosure remedy should not be the only factor considered in selecting LLC jurisdiction.
We mentioned Delaware due to the popularity and we mention Nevada due to the changing laws. Nevada was at one time staunch protection for the corporate veil. However, since July 1, 2007 Nevada has adopted new legislation that requires reporting to the Secretary of State, thus outlawing Bearer Shares.
You can incorporate yourself by applying to the Secretary of State. If you choose to do this yourself, you should have great knowledge of business law behind your decision including the statures, the taxation and reporting requirements.