By Jeffrey H. Lerman, Esq., The Real Estate Investor’s Lawyer™ (www.RealEstateInvestorLaw.com)
Nevada has just passed a new law (SB405) that could provide business owners greater protection from creditors (the law goes into effect October 1, 2011). It addresses existing problems in at least two areas in the world of asset protection: single member limited liability companies (SMLLCs) and charging orders.
The highlights of this new law:
1. Single Member LLCs and Single Shareholder Corporations
Here’s the problem that currently exists. In recent years, a few bankruptcy courts outside of California have allowed creditors to do something to owners of SMLLCs that they could not do to owners of LLCs with more than one member: pierce the LLC protective veil and get to the owner’s personal assets. The detailed legal explanation of the courts’ reasoning in those cases is beyond the scope of this article. The impact, however, is effectively to put the smaller investor (including the husband and wife, who are treated as a single member in the eyes of the law) at greater risk from creditor attacks than the larger investors (who generally have a greater ability to include at least one additional member in their LLCs). That different treatment just feels unfair, regardless of what road the court takes to reach that conclusion. In our law firm, we routinely advise our clients contemplating the SMLLC to address this risk (even though no California court has followed this trend yet) by adding at least one member to their LLC, even if that member owns a relatively small percentage interest (for example, 5-10%).
The new Nevada law addresses that problem to a certain extent by specifically making the charging order the exclusive remedy of a judgment creditor for Nevada LLCs, corporations and LPs, specifically including both single member LLCs and single shareholder corporations. A charging order is essentially an order issued by the court granting the judgment creditor a lien over the judgment debtor’s interest in the business entity. This is the same remedy a creditor could get against the multi-member LLC. By making the charging order the exclusive creditor remedy against SMLLCs, it means creditors cannot foreclose on that charging order lien and get to the SMLLC owner’s personal assets.
2. No Equitable Remedies
The second problem addressed by the new law involves alternate equitable remedies. Before SB405, even if the charging order was deemed the exclusive creditor remedy (for multi-member LLCs), a creditor could still potentially get to the individual behind the entity by using certain equitable remedies such as reverse veil piercing, alter ego, constructive trust and resulting trust theories.
SB405 closes that “loophole”. It adds language to the Nevada LLC, LP and corporation statutes specifying that no other remedies (i.e., no equitable remedies) can apply. There is one exception to this new law only with respect to corporations, allowing the alter ego theory to be the exclusive equitable remedy to apply to corporations.
While SB405 is certainly a significant development in the law of asset protection in general, the key question, as with so many asset protection laws, is how this new legislation would apply, if at all, to you. Whenever a business operates across state lines, any legal dispute triggers a “conflict of laws” issue: which state’s laws govern the resolution of the dispute?
So, if you’re a California resident and use a Nevada LLC to own your California property and get sued by a California resident, then under current California law, the court would most likely apply California law to your case and, odds are, Nevada’s SB405 would not help you. That could change at any time. Moreover, if you get sued in a court outside California, that state’s different “conflict of laws” rules would determine whether SB405 would apply or not. If you own property in Nevada, however, SB405 could be a real game-changer, for your benefit.
If you would like more information about this topic and how it applies to your unique situation, or if you would like to discuss any real estate investing legal issue, please contact Jeff Lerman, Esq., The Real Estate Investor’s Lawyer™, at firstname.lastname@example.org.