Set Your Sights on "Situs" Considerations

"Situs" is Latin for the location or position of something for legal purposes. In other words, situs means "the law of the place where the thing in issue is situated."[1] In the context of business-entity issues, the situs of an entity determines the jurisdiction that governs the entity. Because certain states have more favorable debtor laws than others, situs determinations can have a critical impact on the outcome of litigation. Illinois, for example, has laws which cater to creditors, thereby making it a "creditor-friendly" state. On the other hand, Delaware and Nevada have among the most favorable debtor legislation in the nation, often referred to as "debtor-friendly" laws. As such, Delaware and Nevada are generally preferable jurisdictions in which to situs a business entity.

IMPACT OF SITUS

Situs impacts two aspects of an entity's legal affairs: (1) the law that will govern adjudication of the events at issue in a lawsuit; and (2) the state in which an organization may be sued.

Essentially, by creating an abundance of contact with a debtor-friendly state (such as Delaware or Nevada), an entity can reinforce the assertion that such state's law will be applied to any legal issue. Simultaneously, a concentration of contacts with a "debtor-friendly" state also works to minimize contacts with a "creditor-friendly" state (such as Illinois) and can therefore negate application of such state's "creditor-friendly law."

For example, even if an entity is formed under Delaware or Nevada law, a creditor could nonetheless establish that Illinois law should apply to a given issue if the entity has an Illinois presence through utilizing an Illinois address and accepting mail in Illinois. On the other hand, when an entity has an address within Delaware or Nevada, and conducts business through such address, it is more likely that Delaware law or Nevada law will govern. In essence, formation in a state, without situs in such state, will likely not help an entity take full advantage of such state's laws.

1. Choice of Law Provisions

A general principle of law is that the interests of the parties are determined by the law of the state which has the most significant relationship to the issue involved and the parties.[2] Accordingly, an entity with a "Delaware-situs" will have a significant relationship to the State of Delaware and its laws, and an entity with a "Nevada-situs" will have a significant relationship to the State of Nevada.

2. Establishing Jurisdiction

Jurisdiction, in particular "personal jurisdiction," is the power of a court over the defendant's person or property. There are two types of personal jurisdiction: (a) general; and (b) specific. When a court has general personal jurisdiction over a defendant, the defendant may be sued in such court for any issue. In order for a court to have specific personal jurisdiction over a defendant, the act in the state must have a specific connection with the lawsuit filed.

A defendant can subject himself to general personal jurisdiction in a particular state's court by doing business in that state. "Doing business" is generally defined as regular, systematic, ongoing, in-state business. Merely soliciting business in a particular state is not enough to subject a defendant to general personal jurisdiction.[3]

Whether an entity is "doing business" in a particular state is a fact-intensive, case-by-case inquiry. Therefore, for situs purposes, it is important to establish favorable facts and connections to a state with "debtor-friendly" laws, and minimize connections with "creditor-friendly" states.

For example, maintaining a business address in Delaware or Nevada, accepting mail in Delaware or Nevada, and housing corporate records in Delaware or Nevada, are all favorable connections with the State of Delaware or the State of Nevada, as the case may be. These connections would therefore enhance the position that Delaware law or Nevada law, as the case may be, is applicable to any issue.

HEIGHTENED ASSET PROTECTION

"Debtor-friendly" laws provide heightened asset protection to entities governed by them. This point again underscores the importance of "situs" in preferable jurisdictions.

For example, unlike most jurisdictions, Delaware law allows any asset to be owned as tenancy by the entirety, including interests in business entities. Tenancy by the entirety is a form of ownership reserved to husbands and wives, whereby the husband is not considered to own an interest and the wife is not considered to own an interest, but rather the fused marital unit is considered to own the entire interest.

Tenancy by the entirety ownership provides heightened asset protection because a creditor of the husband cannot reach the asset to satisfy a debt, and a creditor of the wife cannot reach the asset to satisfy a debt; only a joint creditor may reach the asset to satisfy a debt under which both the husband and wife are jointly liable.

Another "debtor-friendly" concept is that of charging-order protection. Suppose a creditor was owed a debt by an individual debtor. In order to collect on the debt, the creditor would petition a court for an "interest" in the debtor's assets, such as the debtor's membership interest in a limited-liability company (for example). A judge could issue a charging order in favor of the creditor, which is similar to a lien against the membership interest. However, a creditor has no ability to foreclose upon such interest granted by the charging order. Thus, the creditor will not be able to own or possess such interest. Further, a charging order does not grant the creditor any management or voting rights because the creditor has only the rights of an assignee/transferee. In other words, the creditor's remedy is limited to the debtor's share of distributions, yet the creditor has no power through which to force the entity to make distributions.

Charging-order protection, in general, can be viewed as an asset protection tool. However, not all charging-order protection statutes are created equal. Certain "debtor-friendly" states have enhanced their statutes to maximize protection afforded to entity interests. For example, under both Delaware law and Nevada law, charging-order protection is a creditor's exclusive remedy with regard to partnership and limited-liability company interests.

Traditionally, charging-order protection has not been afforded to corporations. Thus, upon default, a creditor could step into the shoes of a debtor, gaining access to the rights a debtor has regarding stock owned, including the right to share in profits, the right to share in liquidation proceedings, and the right to vote for directors of the corporation. In this way, the creditor has the power to reach the stock of the corporation, particularly if the creditor steps into the shoes of a majority shareholder.

However, recently, Nevada enacted "debtor-friendly" legislation making it the only state in the nation to offer charging-order protection to corporations, in addition to partnerships and limited-liability companies.

This is an important distinction to note: while corporations are often thought of as having "limited liability," the limited liability is with regard to the individual shareholder when the corporation itself is sued. Conversely, unless the corporation is incorporated under Nevada law, the same limited liability does not apply to the corporation (i.e., the stock of the corporation) when the shareholder is sued.

In conclusion, when forming an entity, "situs" issues should be considered. An entity formed under a jurisdiction with "debtor-friendly" laws such as Delaware and Nevada can achieve not only "litigation advantages," but can maximize asset protection afforded to the entity and its owners.