Lately, more and more clients ask what they can do to protect their small businesses. Most understand that corporations and limited liability companies (LLCs) may shield them from personal liability for the debts and other obligations of the business; however, they seem to be unclear as to how the law works in the opposition direction. How can an owner protect their small business from claims for their own personal liabilities?
Owners should start the legal planning for their businesses and asset transfers before they even form a company. Nevada law limits a person’s ability to transfer assets to businesses they own in an effort to avoid their personal creditor’s claims.1 A creditor may disgorge assets from a person’s business if the person transferred those assets “[w]ith actual intent to hinder, delay or defraud [the] creditor” or “[w]ithout receiving a reasonably equivalent value in exchange for the transfer.” 2 Creditors routinely file lawsuits against businesses that receive such transfers, although, as discussed below, certain types of trusts may impede creditors’ efforts.
Business owners must not operate their businesses as their own “alter egos.” An owner’s personal creditor may reach the business’s assets when an alter-ego situation, such as the following, exists: “(1) commingling of funds; (2) undercapitalization; (3) unauthorized diversion of funds; (4) treatment of [business] assets as the individual’s own; and (5) failure to observe corporate formalities.” 3
In Nevada, barring fraudulent transfer or alter ego, a small business owner’s creditor generally may not touch the assets of the owner’s business, if it is an LLC or corporation. With respect to LLCs, the creditor is usually limited to a charging order—obtained after a judgment—which only allows for collection on distributions actually made.4 “A judgment creditor . . . is only entitled to the judgment debtor’s share of the profit and distributions, takes no interest in the LLC’s assets, and is not entitled to participate in the management or administration of the business.” 5 The result is the same for most small corporations; the creditor may generally only execute on the owner’s stock (ownership interest) if the corporation is publicly traded or has 100 or more shareholders.6 Although LLC and corporate assets are similarly protected, LLCs are often preferred for small businesses because corporations require various formalities, such as annual meetings, and the annual fees for Nevada corporate business licenses have recently increased to be $300 more than for other entities.
Nevada residents (and even non-residents) may also protect their businesses by transferring ownership to a Nevada Asset Protection Trust (NAPT).7 NAPTs allow a trust’s creator to be the beneficiary.8 The creator may manage and invest the NAPT’s assets, including business entities transferred to the NAPT, so long as a Nevada resident trustee has the unfettered discretion to approve trust distributions to the creator (as a beneficiary).9 An NAPT may also cut short the time that a creditor has to bring an action for alleged fraudulent transfers, and such a trust may prevent the creator’s creditor from obtaining any trust distributions.10 Assets transferred to the NAPT should be located in Nevada. Nevada law protects NAPT property and assets located in Nevada, including real estate, from judgment collection.11 These protections do not extend to any property or businesses located in another state.
While it has become easier to form a business without the assistance of an attorney, taking advantage of the laws protecting a business (from formation on) have never been more complex. Business owners should always consult an attorney to take full advantage of these laws.
By R. Duane Frizell, partner and Jonathan C. Callister, partner, Callister & Frizell