Where to Form an LLC?

Which state offers the most benefits?What is the best and most common approach?

• Nevada?
• Delaware?
• Your Home State?

In Which State Should You Form Your New Entity?

The basic recommendation is to form your 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 LLC, and perhaps register as a foreign 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.

• Forming a LLC in Your Home State
  Many small businesses prefer to form an LLC in their home state. Typically, it is least complicated and most cost effective to incorporate in the state where you are planning to operate your business. If you incorporate outside your home state, you still may be required to qualify to do business in your home state. The cost of a local formation will usually be less than incorporating in another state and then qualifying to do business in your home state as a "foreign" (out of state) corporation. Plus, you will avoid paying franchise taxes and filing annual reports in two different states.
  
• Advantages of a Delaware Corporation or LLC
  Over 50% of all companies on the NY Stock Exchange are Delaware corporations. Delaware has a long heritage as a business-friendly state and may be a good choice if you intend to take your company public and offer publicly traded stock. Delaware has many other advantages, including low incorporation fees, low annual franchise taxes, and no state corporate income tax for corporations that operate outside of Delaware . Furthermore, Delaware maintains a separate court system for business, called the "Court of Chancery." This Court is known for its well-established record of decisions and speed at which it handles disputes. So instead of spending your valuable time in court, you can spend it running your business. Be aware, however, that if you incorporate in Delaware while your business is located outside of Delaware , you may need to qualify to do business in your home jurisdiction. This may require an extra step and an additional fee to your home state. Nationwide Incorporating Services can assist you with incorporating or forming your LLC in Delaware and qualifying that corporation or LLC in any state you choose.
  
• Advantages of a Nevada Corporation or LLC
  Nevada has become increasingly friendly to corporations with its privacy and liability protection status as well as certain tax advantages. Nevada has no state tax on corporate profits, no state annual franchise tax, or no state personal income tax. Stockholders of a Nevada corporation are not public record, allowing complete anonymity. Be aware, however, that if you incorporate in Nevada while your business is located outside of Nevada , you may need to qualify to do business in your home jurisdiction. This may require an extra step and an additional fee to your home state. Nationwide Incorporating Services can assist you with incorporating or forming your LLC in Nevada and qualifying your corporation or LLC in any state you choose.
  
• The Latest Research Comparing Nevada vs Delaware !
  
• Can a Delaware or Nevada Corporation or LLC Do Business in Other States?
  Yes. Nearly half of the corporations listed on the New York Stock Exchange are Delaware corporations and numerous large businesses are relocating to Nevada . These large companies conduct business throughout the U.S. and abroad. They must, of course, conform to the laws of any jurisdiction they enter. Many states require that any foreign (out of state) corporation qualify to do business in their state prior to actually conducting business there. The Company Corporation® can assist you in qualifying your corporation or LLC in any state you choose.

Nevada vs. Delaware

The Latest Research!

This research reviews the accuracy of claims made in " Nevada vs. Delaware," reported on many web sites in our industry. The issues will be discussed in the order presented in the report. Specifically, there are five areas wherein it is asserted that a specific act would be protected under Nevada law, but a corporate director or officer would be exposed to liability in Delaware. Research reveals that the report is quite accurate.

1. ACTS OR OMISSIONS NOT IN GOOD FAITH

Before it was amended, effective June 15, 2001, Nevada Revised Statutes (NRS) 78.037(1) allowed a Nevada corporation's articles of incorporation to contain:

• A provision eliminating or limiting the personal liability of a director or officeholder to the corporation or its stockholders for damages for breach of fiduciary duty as a director or officer.

However, such protection was prohibited for "acts or omissions, which involve intentional misconduct, fraud or a knowing violation of law." i

Before this change was made it was discussed in David Mace Roberts & Rob Pivnick, "Tale of the Corporate Tape: Delaware, Nevada and Texas," ii

• Without doubt on this subject, Nevada is more director and officer friendly than either Delaware or Texas . . .The NRS seems to imply that a limitation of liability statement may exculpate directors for a breach of the duty of loyalty, acts not in good faith , and receiving improper benefits. If true, directors may act contrary to the interests of the corporation by receiving improper benefits or otherwise act in bad faith, without vicarious liability , if the articles of incorporation eliminate director liability for such acts. iii

Effective June 15, 2001, a subsection (7) was added to the statute: iv

• A director or officer is not individually liable to the corporation or its stockholders for any damages as a result of any act or failure to act in his capacity as a director or officer unless it is proven that:

(a) His act or failure to act constituted a breach of his fiduciary duties as a director or officer;  

(b) His breach of those duties involved intentional misconduct, fraud or a knowing violation of law.


This subsection, in effect, gives all directors and officers of Nevada corporations the protection that the former NRS 78.037(1) merely allowed corporations to include in their articles. In other words, all Nevada corporations now have a limitation of liability statement for directors and officers imposedby law . And, this protection includes acts not in good faith, since NRS 78.138(7) tracks the language of the former NRS 78.037(1). With these amendments, in Nevada, there no longer exists corporations that have limitation of liability statements, and corporations that do not.

In Delaware , such is not the case.

When a Delaware corporation's articles of incorporation do not contain a limitation of liability statement, the protection provided for directors from personal liability comes under the business judgment rule. "As a substantive rule of law, the business judgment rule provides that there is no liability for an injury or loss to the corporation arising from corporate action when the directors, in authorizing such action, proceeded in good faith and with appropriate care." v

This being the case, an act of a Delaware corporate director not in good faith, which rises to the level of "gross negligence," can lead to personal liability if the corporation has no limitation of liability statement in its articles. When such a statement does exist, acts not in good faith are still not protected.

The Delaware General Corporation Law (GCL) is codified vi and this section, which covers only directors, allows a provision in the articles of incorporation:

• Eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director: (i) For any breach of the director's duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under § 174 of this title; or (iv) for any transaction from which the director derived an improper personal benefit. No such provision shall eliminate or limit the liability of a director for any act or omission occurring prior to the date when such provision becomes effective. ix

The legislative commentary viii "makes clear that no such provision shall eliminate or limit the liability of a director for . . . failing to act in good faith." ix

Delaware statute quoted above treats intentional acts of misconduct and knowing violations of law as different from acts or omissions not in good faith.

It is noteworthy to mention that section (ii) of the Delaware statute quoted above treats intentional acts of misconduct and knowing violations of law as different from acts or omissions not in good faith. This bolsters the interpretation x above, as under that statute a Nevada director is only liable for breaches of fiduciary duty that involves intentional misconduct, fraud, or knowing violations of law. Thus, such are not acts "not in good faith."

In Delaware, under no circumstance is a director protected for acts not in good faith. However, in Nevada, such acts are protected, either by a limitation of liability statement found in the articles of incorporation before June 15, 2001 or xi since then. Therefore, on the issue of corporate director acts not in good faith, Nevada law provides protection not found in Delaware law.

2. ACTS BY OFFICERS EXEMPT FROM MONETARY DAMAGES

xii A limitation of liability statement in the articles of incorporation could include officers as well as directors. This made Nevada one of only six states to have such laws covering officers as well as directors. (The other five states are Louisiana, Maryland, New Hampshire, New Jersey, and Virginia.) xiii

With the recent changes to Nevada's corporate laws, a limitation of liability statement is no longer needed for officers or directors. xiv To repeat, this section, applicable since June 15, 2001, is a statutorily imposed limitation of liability statement for officers and directors. Only acts of intentional misconduct, fraud, or a knowing violation of law will lead to an officer's (or director's) liability.

With the recent changes to Nevada's corporate laws, you no long need a limitation of liability statement for officers or directors
Protection for officers in Delaware corporations is nearly non-existent. GCL. xv allows limitation of liability statements in the articles of Delaware corporations, applies on its face to directors only. xvi

Protection for officers in Delaware corporations is nearly non-existent.
When a director is not protected by a limitation of liability statement in the articles, he can still find solace in the business judgment rule. Not so for officers of Delaware corporations. "Some states extend the business judgment rule to officers as well as directors, limiting officers' liability to gross negligence." xvii

"Most jurisdictions, though, have not addressed the application of the business judgment rule to officers. The reason for this is unclear. In any event, it is prudent for officers to assume that they will have exposure for ordinary negligence." xviii As you can see, Nevada corporate law provides substantial protection from monetary damages for corporate officers.

Delaware provides little to no protection for officers. On this issue, Nevada law is superior.

3. BREACH OF A DIRECTOR'S DUTY OF LOYALTY

Under the former NRS 78.037(1), a limitation of liability statement in a Nevada corporation's articles of incorporation protected directors from personal liability except in cases of intentional misconduct, fraud, or a knowing violation of law. As we mentioned, this protection has now been codified at NRS 78.138(7), giving all Nevada directors a limitation of liability statement as a matter of law.

In reviewing the "intentional conduct, fraud, or a knowing violation of law" language of the former NRS 78.037(1), XIX stated that this "seems to imply that a limitation of liability statement may exculpate directors for a breach of the duty of loyalty." XX Their conclusion is sound, given the language of the statute. Since NRS 78.138(7) mirrors the language of the former NRS 78.037(1), their conclusion is equally applicable to the new statute. Thus, Nevada laws appear to protect Nevada corporate directors from breaches of the duty of loyalty. Delaware law does not follow suit.

Nevada laws appear to protect Nevada corporate directors from breaches of loyalty duty. Delaware law does not follow suit.

In Delaware corporations when the articles include a limitation of liability statement, the limits of GCL § 102(b)(7) come into play. This section reads, in pertinent part, that a limitation of liability

• provision shall not eliminate or limit the liability of a director: (i) for any breach of the director's duty of loyalty to the corporation or its stockholders.

The courts in Delaware have construed this section literally, holding that a limitation of liability statement in a Delaware corporation's articles pursuant to § 102(b)(7) shields directors from breaches of the duty of care (i.e., for acts of "gross negligence"), but not for breaches of the duty of loyalty. XXI   "A breach of loyalty claim requires some form of self-dealing or misuse of corporate office for personal gain." xxii When a corporation's articles do not include a limitation of liability statement, and thus §102(b)(7) is inapplicable, the only protection available for Delaware directors is the business judgment rule. However, this rule does not protect directors who breach their duty of loyalty.

xxiii The fiduciary duties of directors include a duty of care and a duty of loyalty. xxiv This latter duty has been described as follows:

• The duty of loyalty is a broad and encompassing duty that, in appropriate circumstances, is capable of impressing a special obligation upon a director in any of his relationships with the corporation. This duty of loyalty embodies both an affirmative duty to protect the interests of the corporation and an obligation to refrain from conduct that would injure the corporation and its stockholders or deprive them of profit or advantage. In other words, directors must eschew any conflict between duty and self-interest. xxv

In Delaware, a breach of the duty of loyalty is not protected by the business judgment rule. xxvi

Thus, on this issue once again, Nevada law provides more protection for directors than does the law of Delaware .

4. TRANSACTIONS INVOLVING UNDISCLOSED PERSONAL BENEFIT TO A DIRECTOR

This issue is closely related to the issue of the duty of loyalty. In Delaware, interested director transactions are allowed and are valid if 1) there is good faith approval by a majority of disinterested directors upon full disclosure; 2) there is approval by shareholders after full disclosure (interested shareholder votes do not count); or 3) the transaction is fair and either approved or ratified by the directors or shareholders. xxvii Nevada law is similar. xxvii These statutes involve disclosed transactions. When an undisclosed transaction occurs, the two states differ.

In Nevada, the former NRS 78.037(1) allowed limitation of liability statements in corporate articles, except for acts or omissions involving intentional misconduct, fraud, or a knowing violation of law. As interpreted by Roberts & Pivnick, supra, this seemed "to imply that a limitation of liability statement might exculpate directors for . . . receiving improper benefits." xxix

Once again, since the new NRS 78.138(7) codifies the limitation of liability statement as a matter of law for Nevada corporate directors, the same conclusion still pertains.

Nevada corporate directors are apparently protected in situations involving transactions when they receive undisclosed personal benefits.

This is not the case in Delaware

Undisclosed personal benefits to a Delaware director are an issue of the duty of loyalty. ( See the previous section, especially the quotes from Graham v. Taylor Capital and Ward, et al.) As such, Delaware law does not protect them, either in situations involving GCL § 102(b)(7) or under the business judgment rule.

Even beyond this, in cases involving director interest in a corporate transaction, the business judgment rule is inapplicable, and the director has the burden of proving the transaction is "fair." If he cannot do so, he is liable. xxx The director's only hope is to disclose the transaction, and come within the terms of GCL § 144(a), supra. If he does so, the business judgment rule applies, unless the transaction rises to the level of disloyalty to the corporation. xxxi

On the issue of undisclosed personal benefits to corporate directors, Nevada law appears to provide protection, whereas Delaware law clearly provides none.

 

 

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