NEVADA CORPORATE LAW

CHOOSING A JURISDICTION

Corporations are creatures of state laws. Therefore, since there are fifty different states, there are fifty distinct sets of laws under which you can potentially choose to incorporate. Each state's corporate statutes have overt or subtle features that may either attract or deter potential incorporators from choosing that particular state. For example, Delaware has corporate fees that might seem excessive to a small businessperson, while its shareholder laws may be attractive to larger ventures. The result: small businesses would probably incorporate elsewhere (such as Nevada), while big businesses would look favourably at Delaware.

As noted above, one of your major decisions as a potential incorporator is selecting the state in which you wish to incorporate. Dissecting the relevant laws of all fifty states is a lot to handle, so it would probably make sense to begin by selecting the various key benefits you would like to attain and then conducting a limited inquiry to identify states that meet those criteria. If this still strikes you as overly burdensome, there are simpler methods you can use.

Obviously, the path of least resistance is to just go ahead and incorporate in the state in which you live or in which your business is owned. While this approach is oftentimes the easiest, those pursuing it will never know how much money they might have saved (through tax reduction, for example, or annual corporate filing fees) or what kind of legal hassles they might have avoided had they formed their corporation in some other jurisdiction. I would never discourage clients from deciding to incorporate in their home state, but I would like to see such a decision result from careful analysis, rather than from an excuse to avoid analysis. Another relatively easy way to decide where to incorporate is simply to follow in the footsteps of successful corporations that do what you do. You can look at different states and determine, by the number of entities formed within the state, whether or not that state is a "corporate haven." Under this approach, you are deferring to the analyses and judgment of others, and hoping they know (or knew) what they're doing. Again, this is no substitute for your own research and careful deliberation. Finally, reading trade publications or asking your professional advisors where to incorporate and why is another route that can save you a great deal of time and energy.

At a minimum, I would suggest that you consider the following factors in determining which state is right for you:

• The unique laws the state offers;
• The costs of doing business within that state; and
• The reputation of that state for your particular business.

These factors should provide you with a solid basis upon which to make a decision. Given the fact that I deal mostly with small businesses and with clients who want as much anonymity as possible, I generally lean towards Nevada because of its unique corporate laws and its low costs of doing business. To be fair, I will contrast these Nevada benefits to those of Delaware, which was, until recently, the undisputed "king" of corporate havens.

JURISDICTION AND LIABILITY PROTECTION

Liability in General

A primary concern for most incorporators is the degree of liability protection afforded by the particular state in which they are incorporating. First, it is important to understand that courts view corporations as artificial people. When a corporation is sued, it is the corporation, not its owners, that is subject to judgment claims and/or the claims of creditors. This limitation of personal liability is one of the most significant advantages of the corporate structure.

There can, however, be exceptions to the "limited liability" concept. Specifically, when certain minimum requirements of maintaining a corporation have not been met (such as keeping proper records, holding required meetings, and so forth), or when the owners have committed criminal or fraudulent acts, courts may "pierce the corporate veil." This means that courts may disregard the corporate structure in such cases and impose personal liability on the owners as though no corporation existed. Assuming you do not intend to incorporate in order to commit criminal or fraudulent acts, and assuming you can easily comply with any state's minimal corporate maintenance requirements, you need not be overly concerned about having your corporate veil pierced.

Just as you have the right to limit your personal liability for your business activities, you have the corresponding right to keep your business assets separate from your personal affairs and to shield them from liabilities for personal acts. Think of how restrictive the business world would be if there were no way to limit liability. Medical research, alternative energy development, or even the act of hiring employees would all be thwarted by the threat of lawsuits. People who own one business would be afraid to venture into another for fear that a lawsuit against one would topple the other. Fortunately, even though each state has tailored its liability exposure rules somewhat differently, corporations in all states significantly reduce personal liability exposure and therefore provide a useful mechanism for allowing businesses to get started and to grow.

Liability for Directors and Officers

Our primary focus is on the liability of the directors and officers of the corporation. Before we discuss directors and officers, you should have a firm understanding of the corporate structure. For review, here is a simple outline:

Liability of the Directors and Officers of the Corporation
Shareholders
Board of Directors
Officers
President	Vice President	Secretary	Treasurer

 

• Shareholders own the corporation. They have no personal liability for the acts of the corporation or its directors, officers, managers, or employees. The only liability shareholders have is for the amount of money they paid for stock.
• Directors are elected by the shareholders and are responsible for the operations of the corporation. Directors are also charged with appointing the corporation's officers. They are generally protected from liability for their business decisions.
• Officers manage the daily affairs of the corporation. The number of officers required varies from state to state, but President, Vice-President, Treasurer and Secretary are typical. Most states prohibit one individual from occupying all of these positions, but do allow for several offices to be held by one person.
   

The directors and officers are collectively charged with running the corporation, and it should be obvious that the way they exercise this obligation has the potential to create liability for them. Accordingly, most states have laws that establish a standard of care for directors. The majority of states impose an objective standard of care, which means that whatever the directors actually did will be judged against what "reasonable" directors in the same situation would have done. A minority of states impose a subjective standard of care, which means that the only relevant factor is the state of mind of the directors at the time an action was taken. The subjective standard of care is arguably considerably more lenient and more protective of directors than the objective standard. Nevada has such a subjective standard.

Nevada also addresses liability for officers to a degree which other states do not. The Articles of Incorporation in Nevada can expressly eliminate liability for both directors and officers, thereby providing functional immunity to both groups. This fact is unique to Nevada, meaning that if you are planning to be an officer of a corporation, Nevada is the only state that offers you complete immunity. (Remember, though, that no director or officer can be immunized against liability where criminal or fraudulent acts are involved.)

While officer immunity is a wonderful feature for small corporations (i.e. it allows the officers to act with greater freedom and take on greater risk; something that shareholders would probably not appreciate), it is a significant reason why Nevada is the favourite jurisdiction for small corporations. Large corporations, on the other hand, tend to favour Delaware for several reasons, not the least of which is the strong shareholder rights orientation reflected in Delaware statutes. These shareholder rights protections also make Delaware very appealing to companies planning to go public because these companies must attract shareholders to purchase their initial stock offerings. However, not all corporations are large or plan to go public. To the contrary, most are small and do not benefit from the same laws that benefit larger corporations. For them, Nevada is an excellent state in which to incorporate.

The small corporation must also be wary of laws that govern transactions in which the directors or officers have a personal interest. For example, in Delaware, director liability cannot be eliminated for contracts entered into in which a director has a personal interest. Unfortunately, this would defeat the purpose of incorporating for many small businesspeople. This is one reason why so many small businesses choose to incorporate in Nevada, where liability can be waived for directors who have a personal interest in the contract entered into.

A peripheral issue that has an impact on many small business owners is the number of individuals required to run a corporation. State laws vary as to how many directors or officers are required and whether or not the same person can occupy multiple positions. Luckily for the solo businessperson, Nevada allows "one-person" corporations. This means that one person can occupy all of the officer and director positions simultaneously.

The following chart illustrates the difference between Delaware and Nevada laws governing liability of directors and officers:

 

Liability Chart for Certain Acts
Director's Conduct	Nevada	Delaware
Intentional misconduct	Cannot Waive	Cannot Waive
Criminal Acts/Fraud	Cannot Waive	Cannot Waive
Personal Benefit	Can Waived	Cannot Waive
Material interest in contract	Can Waive	Cannot Waive
Breach of duty of loyalty	Can Waive	Cannot Waive
Officer's Conduct
Intentional misconduct	Cannot Waive	Cannot Waive
Criminal Acts/Fraud	Cannot Waive	Cannot Waive
Personal Benefit	Can Waive	Cannot Waive
Material interest in contract	Can Waive	Cannot Waive
Breach of duty of loyalty	Can Waive	Cannot Waive

 

Jurisdiction and Costs

The next area of concern for the incorporator involves the costs of incorporating in a particular jurisdiction. It is an accepted fact that many small businesses fail. The reason is generally quite simple: not enough money. Obviously, then, it is essential to minimize costs and keep as many dollars within the business as possible. Therefore, jurisdictions with low incorporating costs and limited taxes or fees are of special value to the small businessperson.

While Nevada and Delaware are both inexpensive states within which to incorporate, Nevada offers the added allure of having no franchise tax, no state corporate tax, and no taxes on shares issued. (Remember, this is in addition to Nevada's favourable liability protection features.) In Delaware, on the other hand, one can expect to pay state corporate taxes and franchise taxes in varying amounts, depending on how the corporation is set up.

Clients sometimes ask me how it is possible to avoid such a significant amount of taxation simply by incorporating in Nevada, given the notorious aggressiveness of the IRS. My response is short and direct. The IRS deals with federal tax issues. Notice that Nevada does not eliminate federal taxes, only state taxes. This means that Nevada corporations must still pay their federal taxes; they only avoid having to pay a state tax to Nevada.

Thus far, Nevada has been seen as an advantageous jurisdiction for incorporating both in terms of liability protection and tax treatment. There are more advantages still.

Jurisdiction and Anonymity

Nevada is the only state in the Union that does not have a formal agreement with the IRS for information sharing. This raises two immediate questions: 1) "Why does the IRS allow this?" and 2) "Why is this important?" The answers may surprise you. First, the IRS cannot force a state to enter into such an agreement. Information sharing agreements are generally entered into for mutual benefit. For example, if you filed your state taxes in California and the numbers were different than those on your federal return, both the IRS and the state of California would want to inquire into the discrepancy. In essence, this is just another way for the taxing authorities to squeeze more money out of your pocketbook. As to why this is important to you, the real question is: Do you want to do business in a state that hands over your financial information to a federal agency, or do you prefer to keep your affairs private?

Most of the clients I deal with are small businesses. They do not want to get entangled in a bureaucracy and they wish to avoid dealing with federal agencies as much as possible. Because of Nevada's hands-off approach to corporations and the absence of a formal information sharing agreement with the IRS, Nevada has become a favorite state of incorporation.

Take a moment and call the office of the Secretary of State for Nevada. Ask them what information they keep for the corporations on file in their state. You will find out that only the President, Treasurer, and Secretary are listed as officers and that only one director has to be listed along with the resident agent. None of these individuals has to be a shareholder. In fact, because of the limited amount of information kept by the state, you would not be able to ascertain who owns the corporation, how much capital the corporation has, who the previous officers and directors were, or even how much stock has been issued by the corporation. Finally, information on file is updated only once a year, so the information you receive may not even be currently relevant.

As you know, we live in a litigious era. Understand that with a Nevada Corporation, a potential plaintiff will have a very difficult time obtaining information. Sometimes businesspeople want to keep their names out of the public eye because they are famous. Whatever the reason, Nevada has the laws to facilitate their needs.

The following table shows the categories of information required to be kept by the Secretary of State in Nevada, as well as the categories of information not required to be kept. Note that the individuals listed do not have to be stockholders in the corporation or have any ownership interest whatsoever. This will be discussed in more detail later in the text.

 

What information is provided from the Nevada Secretary of State
Is the corporation in good standing?	Yes
Who is the President?	Yes
Who is the Vice-President?	No
Who is the Treasurer?	Yes
Who is the Secretary?	Yes
How much stock has been issued?	No
Who are the stockholders?	No
What does the corporation own?	No
How much money does the corporation have?	No
Who are the current officers and directors?	No

The types of information not available from the office of the Secretary of State in Nevada would normally be found on state corporate tax returns, which are considered public information. However, because Nevada does not charge a corporate tax, there are no state corporate tax returns. If there are no returns, the inquiring person has hit another dead-end and will have to look elsewhere.

Where does the information on stockholders exist? The answer is the stock ledger. The resident agent keeps records on the individual who has possession of the ledger. That person does not have to reside in the United States, and the stock ledger itself is not required to be in Nevada. The stock ledger, the only written source for information on stock ownership (we will shortly be discussing bearer shares as well), can be kept by a relative, friend, or attorney who lives in another state or country. Imagine contemplating a potential lawsuit against a Nevada Corporation and being forced to incur the costs of locating the ledger. Is it worth pursuing?

Another unique aspect of Nevada corporate law is the ability of a corporation to issue "bearer" shares. In plain English, this means that instead of having the name of the shareholder appear on the stock certificate, the certificate is made out to "Bearer." The bearer is simply the person holding the stock. While the stock ledger explains that the bearer stock was issued to an individual and records the name of that person, that individual does not have to be the true holder of the stock.

For example, the stock ledger may show the shares being issued care of Tom Smith, attorney at law, who in turn distributes them to his client. The relationship between Tom Smith and his client creates what is known as an attorney/client privilege. This means that the dealings between Attorney Smith and his client are protected and not subject to judicial inquiry. Therefore, should someone actually succeed in locating and inspecting the stock ledger, he would only find that the stock was issued to Tom Smith, the attorney. When the individual goes to Mr. Smith to try to learn who the recipient of the shares was, the attorney cannot violate his client's privilege and therefore cannot disclose the client's identity.

It should be noted here that there is an absence of definitive case law in this area of "bearer" stock shares. Most attorneys and other professionals do not fully understand the ramifications of using bearer shares. This is not their fault, since bearer shares are untested waters for the most part. Most individuals or companies that run up against ownership issues involving Nevada Corporations are likely to conclude that it is not worth the trouble to pursue and, even if they did, the hurdles set up by Nevada laws would likely force settlement or discontinuation of the case or claim. In other words, because the waters are so murky, nobody wants to jump in.

You should therefore be mindful that bearer shares are not bullet-proof. True ownership does not pass unless noted in the ledger. What if the stock is issued care of your attorney, as in our example? The issue has not been decided in court. Most professionals I have spoken with believe the issue will remain undecided and that the strategy of using the attorney/client privilege will continue to be viable. I would be remiss, however, if I did not point out that a court could still order disclosure from the attorney, however unlikely. As far as obtaining privacy in general, there still is no other state like Nevada.

Most states follow the Revised Model Business Corporation Act (MBCA) for their domestic corporations. The origin of the Act occurred years ago, when a group of law writers came up with a general corporation act. Many states adopted all or parts of the act with only minor changes. Nevada, however, has made significant changes to many of the common provisions of corporate law originally embodied in that Act. The following table briefly lists what information one would expect a stock certificate to contain in an MBCA state and what information a stock certificate is actually required to contain under Nevada law:

Stock Certificate Requisites

	MBCA state	Nevada
The identity of the shareholder?	Yes	No
The name of the corporation?	Yes	Yes
The number of shares represented by the certificate?	Yes	Yes
The number of authorized shares?	Yes	No

As you can see from the chart, anyone desiring anonymity in their corporate affairs would be better served using Nevada as their corporate residence.

Jurisdiction and Capital Requirements

A final aspect of Nevada law that makes the state such an appealing jurisdiction for incorporating is that monetary capitalization of the corporation is not required. This is important because, as many businesspeople have learned the hard way, under-funding a corporation is a basis for piercing the corporate veil. Unfortunately, once your corporation's veil is pierced, the debts of the corporation become your own. Nevada, much to the delight of small businesspeople, eliminated any risk of under-funding by removing all minimum capitalization requirements. This is just one more feature of the Nevada statutory scheme that allows owners of such small businesses to rest easier at night.

SUMMARY OF ADVANTAGES

At this point, I hope that you can fully appreciate what the Nevada legislature has done. They have consciously and intentionally targeted small businesses (and even some large businesses) with a highly favourable statutory system. By so doing, they have made Nevada more appealing as a corporate domicile for the small business owner than any other state. (By the way, an incidental benefit of incorporating your business in Nevada is that visiting your Nevada office is a tax-deductible trip. One final tip: watch out for the one-armed bandits!)

There are so many benefits resulting from the simple act of incorporation, regardless of which state is used, that it is difficult to highlight all of the major ones. When you factor in the special provisions of the Nevada corporate code, you have an extremely powerful tool for asset protection, tax reduction, and estate planning.

For review, here are the major highlights of Nevada corporations:

1. Privacy
2. Nominee officers
3. Bearer shares
4. No state corporate taxes
5. No franchise taxes
6. No taxes on shares issued
7. One-person corporations
8. No minimum capitalization amount
9. Extensive director and officer liability protection
10. No information sharing agreement with the IRS
11. Inexpensive establishment and maintenance costs