In Which State Should You Form Your New Entity?

The basic recommendation is to form your corporation or LLC under the state laws in which the business will operate. If you have a partner and/or business activity in more than one state, you will have to decide in which state to domicile your corporation or LLC, and perhaps register as a foreign corporation or LLC doing business in the state where the activity occurs. You'll make this decision based upon multi-state taxation rules, and registration requirements that vary from state to state.

Many times you hear that Delaware and Nevada are the best states in which to domicile (or form) your new business. Both states have advantages, but not all may apply to your situation. Nevada for example, gives you the following advantages:

1. It's a very difficult state in which to pierce the corporate veil,
2. Indemnification of officers and directors, and
3. No Joint and Several Liability.

Let's examine one at a time. First, what does "piercing the corporate veil," mean? It is the ability of legal prosecution to cross (pierce) the border (veil) between a business and the personal assets of its owners, shareholders, members, or managers. When you form a corporation, whether it's in Nevada, California, Texas or wherever, you must follow certain corporate formalities. If your corporation does not keep accurate records of meetings through minutes, or if it co-mingles funds, prosecutors find it easier to pierce the corporate veil. While a lawsuit typically ends when there is enough insurance or assets to pay off the debt, a plaintiff may attempt to pierce the entity and go after the owners' personal assets if the entity does not hold enough assets to cover the judgment.

In the real world, piercing does not happen that often because a majority of cases are settled out of court. However, when a prosecutor is able to introduce the real possibility of piercing the corporate veil, business owners are put in the uncomfortable position of having to settle for more than they otherwise would to shield their personal assets. On the other hand, when a prosecutor is facing tougher legal obstacles, such as those afforded by a Nevada jurisdiction, you can arrive at settlements more quickly, and for significantly lesser amounts.

Another factor that helps prosecutors pierce the corporate veil is low capitalization. In some states, like California, we recommend that you capitalize your corporation with at least $1,000. If not, it's easier to prove that you are simply the "alter ego" of the corporation (one and the same with the corporation), and pierce the corporate veil! How does Nevada feel about this? Nevada is referred to as a "thin capital state," meaning you can form a corporation for as little as $100, or even comparable services. Also, Nevada maintains a certain attitude about piercing the corporate veil, which is why major corporations domicile in Nevada and register to do business in their home states.

First, Nevada has a three-prong test. Prosecution must prove all three parts to pierce the corporate veil:

1. The corporation must be influenced and governed by the person asserted to be the alter ego;

2. There must be such unity of interest and ownership that one is inseparable from the other; and

3. The facts must be such that adherence to the corporate fiction of a separate entity would,

4. Under the circumstances, sanction fraud or promote injustice.

The burden of proof for these three "general requirements" is on the plaintiff, who seeks to pierce the veil. A failure to prove any of the three will result in the veil not being pierced! Essentially, Nevada says that unless you can prove fraud, the corporate veil will not be pierced. That is awesome protection!

A landmark case proves this point: Rowland v. LePire, 99 Nev. 308, 662 P.2d 1332 (1983). As mentioned before, in order to protect the integrity of the corporate veil, it is important to keep accurate corporate records, and have adequate capitalization. In the case of Roland vs. Lepire, it was clear that there was inadequate capitalization. The corporation had a negative net worth at the time of the trial; no formal directors' or shareholders' meetings were ever held; dividends were not paid to shareholders; and the officers and directors did not receive salaries. There was no corporate minute book, nor was there any evidence that minutes were kept. At the same time, a general contractor's license, a framing contractor's license and a corporate checking account were secured in the corporation's name. The court concluded that, 'Although the evidence does show that the corporation was undercapitalized and that there was little existence separate and apart from [the two key shareholders]…evidence was insufficient to support a finding that appellants were the alter ego of the…corporation.' The Nevada Supreme Court has made clear that unless the plaintiff is able to meet the burden of proving that "the financial setup of the corporation is only a sham and caused an injustice," the veil is unlikely to be pierced.

Nevada appears as an IRON FORTRESS to creditors. The corporate veil has only been pierced once in Nevada in the last 24 years, and that was in a case where the corporation actually did business in Nevada and committed fraud against a Nevada resident.

In 1987, the Nevada Legislature passed a revolutionary law permitting corporations to place provisions in their Articles of Incorporation eliminating the personal liability of officers and directors to the stockholders of Nevada Corporations. This is one of the main reasons large companies like Citibank domicile in Nevada. Delaware and a few other states soon adopted lesser versions of this law, but Nevada's law remains among the most thorough and comprehensive in the country. Contained in the Nevada Revised Statues (78.037), the law in part reads as follows:

"The Articles of Incorporation may also contain:

A provision eliminating or limiting the personal liability of a director or officer to the corporation or its shareholders for damages for breach of fiduciary duty as a director or officer, but such provision must not remove or limit the liability of a director or officer for: Acts or omissions which involve intentional misconduct, fraud or a knowing violation of law."

This Statue was updated on June 15, 2001 to read:

The Articles of Incorporation may also contain any provision, not contrary to the laws of this state:

1. For the management of the business and for the conduct of the affairs of the corporation;

2. Creating, defining, limiting or regulating the powers of the corporation or the rights, powers or duties of the directors, the officers or the stockholders, or any class of the stockholders, or the holders of bonds or other obligations of the corporation; or

3. Governing the distribution or division of the profits of the corporation.

<< Back | Next >>

E-Mail: info@fastbusinesscredit.com

Questions? Call for a Free 30-Minute Consultation!
Call Fast Business Credit Today at
1-888-313-6333!