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The Advantages of
Incorporating in Nevada

I. The Right of States to "Pierce" Foreign Corporations

General View

As previously discussed, California has a reputation for "piercing the corporate veil" in a liberal manner. Further, since California aggressively applies its corporation statutes to foreign corporations, it is likely that its courts would apply the common law doctrine of "piercing" in the same way. See Robert B. Thompson, "Piercing The Corporate Veil: An Empirical Study," 76 Cornell L. Rev. 1036, 1053 (1991).

This presumes, of course, that liability to a third party is not an "internal affair" of a corporation. The courts of this country have never answered this question. See Mark R. Patterson, "Is Unlimited Liability Really Unattainable?: Of Long Arms And Short Sales," 56 Ohio St. L.J. 815, 862 (1995). In general, the law of the state of incorporation controls the internal affairs of a corporation. Many people believe that the internal affairs doctrine was "constitutionalized" by the United States Supreme Court in CTS Corp, v. Dynamics Corp. of America, 481 U.S. 69 (1987). See, Alan R. Palmiter, "The CT8 Gambit: Stanching The Federalization of Corporate Law," 69 Wash. U.L.Q. 445, 501-10 (1991); P. John Kozyris, "Some Observations On State Regulation Of Multistate Takeovers: Controlling Choice Of Law Through The Commerce Clause," 14 Del. J. Corp. L. 499, 515 (1989); Lea Brilmayer, "Rights, Fairness, And Choice Of Law," 98 Yale L.J. 1277, 1298-99 n. 72 (1989); Alan E. Garfield, "State Competence To Regulate Corporate Takeovers: Lessons From State Takeover Statutes," 17 Hofstra L. Rev. 535, 576 n. 220, 582 (1989). If this was so, only the state of incorporation could regulate a matter deemed to be an internal affair of a corporation.

However, since the ruling in CTS Corp., supra, is not clear and may not prevent states from regulating the internal affairs of foreign corporations, see Patterson, supra, 56 Ohio St. L.J. at 858-62; Richard M. Buxbaum, "The Threatened Constitutionalization Of The Internal Affairs Doctrine In Corporation Law," 75 Calif. L. Rev. 29, 34-35 (1987), and, as stated, it is an open question whether liability to a third party is an internal affair, currently states apparently are free to "pierce the corporate veil" of foreign corporations. (Provided other potential constitutional barriers are overcome, as previously analyzed.) In fact, federal courts often reject the notion that the law of the state of incorporation must be applied in determining whether to "pierce the corporate veil." See Henry Hansmann and Reinier Kraakman, "A Procedural Focus On Unlimited Shareholder Liability," 106 Herr. L. Rev. 446, 453 (1992). See also Itel Containers Int'l Corp. v. Atlanttrafik Express Serv., 909 F.2d 698 (2nd Cir. 1991); Yarbrow v. Fed. Deposit Ins. Corp., 150 B.R. 233 (B.A.P. 9th Cir. 1993) (court applied New Mexico law to "pierce" a California corporation where corporation purchased property in New Mexico and committed fraud in so doing).

California's Approach

Given the above, California is apparently within its rights if it "pierces" the veil of a foreign corporation doing business within its borders. Its current test applied in "piercing" cases does not preclude this:

In general, the two requirements for applying the alter ego doctrine are that (1) there is such a unity of interest and ownership between the corporation and the individual or organization controlling it that their separate personalities no longer exist, and (2) failure to disregard the corporate entity would sanction a fraud or promote injustice.

Communist Party of the United States v. 522 Valencia, Inc., 35 Cal. App.4th 980,

993, 41 Cal. Rptr.2d 618, 625 (1995) (citing Mesler v. Bragg Management Co., 39 Cal.3d 290, 702 P.2d 601, 216 Cal. Rptr. 443 (1985); Minifie v. Rowley, 187 Cal. 481, 202 P. 673 (192i)). As you recall, Nevada adopted its "piercing" test from the Minifie casc. See Mccleary Cattle Co. v. Sewell, 73 Nev. 279, 317 P.2d 957 (1957). The Valencia court added:

The doctrine is applicable where some innocent party attacks the corporate form as an injury to that party's interests. The issue is not so much whether the corporate entity should be disregarded for all purposes or whether its very purpose was to defraud the innocent party, as it is whether in the particular case presented, justice and equity can best be accomplished and fraud and unfairness defeated by disregarding the distinct entity of the corporate form.

Valencia, supra, 35 Cal. App. 4^th at 993, 41 Cal. Rptr. 2d at 625. Furthermore, stated that alter ego is a limited doctrine that should only be used in narrowly defined circumstances and only when the ends of justice so require. Id. at 995, 41 Cal. Rptr.2d at 626-27.

Despite the fact that Nevada and California use the same basic test in determining whether to "pierce the corporate veil," "California courts appear to be quite liberal in their application of the piercing doctrine. At least in theory, California is the only state to rely on inadequate capitalization in the piercing decision to the exclusion of all other factors and elements, including improper purpose and unjust results." Comment, "Piercing The Corporate Veil in Federal Courts: is Circumvention Of A Statute Enough?," 13 Pacific L.J. 1245, 1252 (1982). See Minton v. Cavaney, 56 Cal.2d 576, 364 P.2d 473, 15 Cal. Rptr. 641 (1961); but c.f., Pearl v. Shore, 17 Cal. App.3d 608, 95 Cal. Rptr. 157 (1971); Harris v. Curtis, 8 Cal. App.3d 837, 87 Cal. Rptr. 614 (1970).

In Nevada, "piercing" is becoming less likely, and undercapitalization is increasingly becoming an irrelevant factor in the decision to "pierce." See Rowland v. Lepire, 99 Nev. 308, 662 P.2d 1332 (1983);. Thus, a corporation is less likely to face a "piercing" of its "corporate veil" if its case is being heard in a Nevada court applying Nevada law. If one incorporates in California, and does business there, law suits against it will be heard in California courts using California law. However, incorporating in Nevada provides the foundation for lawsuits against such a corporation to be heard in Nevada courts using Nevada law.

II. California's Approach To Choice-Of-Law In The Absence Of A Choice-Of-Law Contractual Provision

To highlight the benefit of incorporating in Nevada, and thus having a reasonable basis for choosing Nevada in both a choice of forum clause and a choice-of-law clause, it is initially necessary to review what can occur in the absence of such clauses. If a foreign corporation does business in California, and is sued in the courts there for actions arising out of its business there, the courts apply a three-part test to determine which state's law will apply to the case:

First, we determine whether the two concerned states have different laws. Second, we consider whether each state has an interest in having its law applied to this case. Finally, if the laws are different and each state has an interest in having its own law applied, we apply the law of the state whose 'interests would be more impaired if its policy were subordinated to the policy of the other state.'

Havlicek v. Coast-To Coast Analytical Services, Inc., 39 Cal. App.4th 1844, 1851, 46 Cal. Rptr.2d 696, 699 (1995)(quoting North American Asbestos Corp. v. Superior Court, 180 Cal. App.3d 902, 905, 225 Cal. Rptr. 877, 879 (1986)).

Not surprisingly, in these situations, California law is almost invariably applied, since the courts generally find that California's interests would be more impaired if any other state's laws were applied. See, e.g., Havlicek, supra (California rather than Delaware law applied on issue of corporate inspection rights); North American , supra (California rather than Illinois law applied on issue of right to bring an action against a dissolved corporation); Dailey v. Dallas Carriers Corp., 43 Cal. App.4th 720, 51 Cal. Rptr.2d 48 (1996) (California rather than Ohio law applied on issue of worker's compensation carrier's right to recover benefits paid to survivors from a third-party tortfeasor); Stonewall Surplus Lines Ins. Co. v. Johnson Controls, Inc., 14 Cal. App.4th 637, 17 Cal. Rptr.2d 713 (1993)(California rather than Wisconsin law applied on issue of an insured party being able to seek indemnity from an insurer for punitive damages).

The above analysis also pertains to cases involving statutes of limitation. In American Bank of Commerce v. Corondoni, 169 Cal. App.3d 368, 215 Cal. Rptr. 331 (1985), the court held that California's ten year statute of limitations for bringing an action to enforce a sister state money judgment applied, rather than New Mexico's seven year statute. The Court stated, rather obviously, that "California's general preference is to apply its own law." Id. at 372, 215 Cal. Rptr. at 333.

As can be seen, if one incorporates in California or another state, and does business in California, the courts in California generally will apply its laws to an action involving that corporation. However, with the use of forum selection clauses and choice-of-law clauses, this can be avoided. And, if the incorporation occurs in Nevada, Nevada's law and courts can be chosen, thus affording protection for the personal assets of the corporation's owners, as Nevada courts are less likely than California courts to "pierce the corporate veil."

III. California's Approach In The Presence Of Forum Selection And Choice-Of-Law Provisions

The approval of forum selection clauses came in Smith, Valentino & Smith, Inc. v. Superior Court, 17 Cal.3d 491, 551P.2d 1206, 131 Cal. Rptr. 374 (1976). Here, a Pennsylvania corporation entered into a contract with a California corporation. The contract included a reciprocal forum selection clause, wherein if the Pennsylvania corporation brought suit it had to do so in Los Angeles, while the California corporation could only sue on the contract in Philadelphia. The contract also stipulated that, wherever a suit was brought, Pennsylvania law would govern. The California corporation brought suit in California alleging breach of contract and other issues. The trial court refused to hear the suit, pointing to the forum selection clause. The California Supreme Court affirmed,

The court stated that "choice-of-law provisions are usually respected by California courts." Id. at 494, 131 Cal. Rptr. at 376. The court also stated that, although there is a public policy favoring access to California courts by resident plaintiffs:

[W]e likewise conclude that the policy is satisfied in those cases where, as here, a plaintiff has freely and voluntarily negotiated away his tight to a California forum. In so holding we are in accord with the modern trend which favors enforceability of such forum selection clauses.

Id. at 495, 131 Cal. Rptr. at 377 (citing The Bremen v. Zapata Off-Shore Co., 407 U.S. 1 (1972). The court added that:

No satisfying reason of public policy has been suggested why enforcement should be denied a forum selection clause appearing in a contract entered into freely by parties who bare negotiated at arm's length.

Smith, 17 Cal.3d at 495-96, 131 Cal. Rptr. at 377.

As this case reveals, a forum selection clause can prevent a California court from even hearing a case, thus negating the opportunity for it to apply California law. Subsequent cases reveal why it is important to incorporate in a state other than California in order to avoid the application of its laws.

In Nedlloyd Lines B.V.v. Superior Court, 3 Cal.4th 459, 834 P.2d 1148, 11 Cal. Rptr.2d 330 (1992), the California Supreme Court reaffirmed its holding in Smith, supra, and specifically extended it to choice-of-law contractual provisions. Here, a Hong Kong corporation, which had its principal place of business in California, entered into a contract with a Netherlands corporation which had its principal place of business in Rotterdam, and also with several other parties including an Oregon corporation, another Hong Kong corporation, a British corporation, a resident of Singapore, and three residents of California. The contract had a clause which read:

This agreement shall be governed by and construed in accordance with Hong Kong law and each party hereby irrevocably submits to the non-exclusive jurisdiction and service of process of the Hong Kong courts.

Id. at 463, 11 Cal. Rptr.2d at 332. The trial court and an appellate court applied California law when one of the parties brought suit in California. The California

Supreme Court agreed to bear the case only on the choice-of-law issue, id. at 464, 11 Cal. Rptr.2d at 332, and reversed.

The court stated:

In determining the enforceability of arm's-length contractual choice of-law provisions, California courts shall apply the principles set forth in Restatement section 187, which reflect a strong policy favoring enforcement of such provisions.

Id. at 464-65, 11 Cal. Rptr.2d at 333. Under Section 187(2) of the Restatement, a court first determines either:

whether the chosen state has a substantial relationship to the parties or their transaction, or (2) whether there is any other reasonable basis for the parties' choice of law. If neither of these tests is met, that is the end of the inquiry, and the court need not enforce the parties' choice of law.

Id. at 466, 11 Cal. Rptr.2d at 334. If either test is met, the court next determines whether the chosen state's law is contrary to a fundamental policy of California. Id. If there is no conflict, "the court shall enforce the parties' choice of law." Id. If there is a conflict, "the court must then determine whether California has a materially greater interest than the chosen state in the determination of the particular issue[.]" Id.

Applying these requirements to the facts at hand, the court found that relation the parties, since two of them were Hong Kong had a "substantial relation to the parties, since two of them Hong Kong corporations. Alternatively, incorporation in Hong Kong of at least one party to the contract provided a "reasonable basis" for choosing Hong Kong law. Id. at 467, 11 Cal. Rptr.2d at 335. Further, the court found no conflict with a fundamental policy of California, as the implied covenant of good faith and fair dealing present in all contracts is not a governmental regulatory policy designed to restrict the freedom to contract, but rather is an implied promise of an agreement to carry out the presumed intentions of contracting parties. Id. at 468, 11 Cal. Rptr. 2d at 335. Since there was no conflict, the court held that Hong Kong law was controlling. Furthermore, the court held that all causes of action arising out of the agreement, whether denominated "contract" or "tort," were included under the choice-of-law provision. Id. at 470, 11 Cal. Rptr.2d at 337.

This case is very important. Incorporation in a state other than California allows that corporation to choose its home state's laws to control its contracts made in California. Further, the choice-of-law provision covers tort as well as contract claims arising out of the agreement. (This rule applies to forum selection clauses as well. See Smith, supra, 17 Cal.3d at 497, 131 Cal. Rptr. at 378.)

As discussed above, in the absence of a choice-of-law clause, California courts almost invariably apply California law after going through the balancing of interests test. However, Smith, supra, and Nedlloyd, supra, show the efficacy of contractual provisions in changing the outcome. These cases are continually being followed. For example, in Hambrecht & Quist Venture Partners v. American Medical International, Inc., 38 Cal. App.4th 1532, 46 Cal. Rptr.2d 33 (1995), the court upheld a choice of-law provision in a contract, and ruled that Delaware law would apply. In this case, the law applied was a statute of limitation, which the court held could be used without violating any fundamental policy of California. As discussed above, in the absence of a choice-of-law provision, the courts in California prefer to apply their own law, even when the issue is the proper statute of limitations. See Corondoni, supra. With such a provision, the analysis changes.

Just last year, in Guardian Savings and Loan Assoc. v. MD Assocs., 64 Cal. App.4th 309, 75 Cal. Rptr.2d 151 (1998), the court again upheld such a provision. Here, the contract at issue was a promissory note which called for the application of Texas law. One of the parties was incorporated in Texas, and thus there was a reasonable basis for choosing Texas law. Under that law, a deficiency judgment following a foreclosure is allowed, while such a judgment is barred in California. Although the court found that this was a fundamental policy of California, it still upheld the use of Texas law, despite the fact that the property at issue was located in California:

While California may have an interest in the performance of a transaction within the state, it has a more questionable interest in the equitable nature of the transaction where the rights and duties of the parties were established by agreement of non-domiciliaries outside its jurisdiction. Such an interest is clearly absent where, as here, the bargain was negotiated between sophisticated, professional investors in a specialized field.

Id. at 322-23, 75 Cal. Rptr.2d at 160.

To be sure, a choice-of-law provision, standing alone, still allows the court to balance interests and apply California law if its interests are greater than the law of the chosen state. This was recently demonstrated in Application Group, Inc. v. Hunter Group, Inc., 61 Cal. App.4th 881, 72 Cal. Rptr.2d 73 (1998), where the court applied California law rather than Maryland law as called for in an employment contract. The contract included a "covenant not to compete." While this was allowable under Maryland law, non-competition clauses in employment contracts violate California public policy. Since the employee worked in California, the court believed that California's interests outweighed Maryland's, and thus refused to apply Maryland law.

IV. The Advantage of Incorporating in Nevada

The result of this case may well have been different if the contract had also included a forum selection clause. A Maryland court would have obviously applied Maryland law as the contract stipulated. These cases reveal that a foreign corporation can do business in California, and yet avoid California's courts and laws through the use of choice-of-law and forum selection clauses. And the underlying requirement for being able to do this is to incorporate outside of California.

For example, if one incorporates in Nevada, he can choose Nevada for his choice-of-law and forum selection contractual provisions. The whole purpose of incorporating is to protect personal assets from the reach of creditors. If a Nevada court hears a case involving a Nevada corporation, using Nevada law, the chances of a "piercing" occurring are slim. And potentially much less so on certain factors involved in "piercing" decisions, such as undercapitalization. Furthermore, if a person is domiciled in Nevada, and their "corporate veil" is "pierced," the exemption laws available here allow for substantial protection of assets, and these can be used in a bankruptcy proceeding, as previously analyzed. Thus, there is an advantage to incorporating in Nevada when it comes to protecting personal assets, which is, after all, the whole point of incorporating.

Since, as stated above, a choice-of-law provision, standing alone, still allows a California court to balance interests in deciding whether to apply the state's law chosen, it is impossible to anticipate what a California court will do in a specific situation. In statute of limitation cases, courts have both upheld the use of the chosen law, and used California law instead. Cf. Hambrecht, supra, with Ashland Chemical Co. v. Provence, 129 Cal. App.3d 790, 181 Cal. Rptr. 340 (1982). In substantive areas of the law, California courts just last year both upheld and denied the use of choice-of-law provisions. Cf. Guardian Savings, supra, with Hunter, supra. Thus, it is not possible to state with certainty that choosing Nevada law will protect a Nevada corporation from the myriad of public policies in California. However, a choice-of-law provision used in conjunction with a forum selection clause, will provide such protection. And, if a company incorporates in Nevada, this state's courts, using this state's laws, will provide substantial protection for the personal assets of the corporator.

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