Friday, August 24, 2007

NEVADA ENACTS CHARGING ORDER PROTECTION FOR CORPORATE STOCK

Nevada recently enacted unique legislation that will enhance the use of its corporations for asset protection purposes. More particularly, it became the first state to enact legislation that provides that a charging order will be the sole remedy for creditors of stockholders of certain Nevada corporations in regard to those shares.

The concept of a "charging order" comes from the partnership and LLC arena. If a debtor owns an interest in a partnership or LLC, and a creditor of that debtor obtains a "charging order" against that interest to collect its debt, the creditor does not become a full owner of the interest. Instead, the creditor's interest is limited to receiving distributions from the entity to the extent that the entity otherwise makes distributions to its owners. If other persons control the entity, this wait for a distribution can be quite lengthy. Further, once the creditor is paid off with distributions, its interest in the entity terminates and the debtor owner thereafter receives back its full ownership rights. Therefore, obtaining a charging order is not as good a remedy for a creditor as being able to force a judicial sale of the interest of the debtor. If the creditor can force a judicial sale, the creditor immediately gets the sale proceeds from the interest – or if it purchases the interest with its debt, it gets full ownership rights forever in the entity and the debtor loses all rights.

Some jurisdictions limit a creditor's rights to a charging order. By doing so, debtors receive creditor protections because the creditor can no longer force

Until the new legislation in Nevada, the charging order remedy had no application to stock in a corporation. By providing that a charging order will now be the sole remedy for creditors of Nevada corporation stockholders as to their shares, Nevada is now providing a significant (and presently unique) method of asset protection.

The new legislation does not apply to all Nevada corporations. For example, the corporation must have more than 1 stockholder and less than 75 stockholders. It cannot be a subsidiary of a publicly traded entity, nor a professional corporation. It will also not apply to any liabilities arising from an action filed before July 1, 2007. Contractual remedies offered by a stockholder to a creditor will not be overriden by the new law.

What happens if the debtor stockholder lives outside of Nevada – will the protection apply? The question of whether the law of Nevada or the law of the residence of the debtor stockholder will apply is unknown – indeed, this is an issue that applies to all the various asset protection statutory protections offered by the various states. Until the issue is resolved, a reasonable approach for persons outside of Nevada is to adopt the attitude of "what do I have to lose" by using a Nevada company, since the possibility that it could work will provide negotiating leverage with creditors. The answer to what is lost by using a Nevada corporation instead of a corporation in one's home state is mostly just the increased costs involved, such as payment of registered agent fees for a local Nevada registered agent, the costs of a service to assist with formation, other Nevada fees, and possibly the need to register the company to do business in a different state.

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