Nevada Becomes the First State to Extend Charging Order Protection to Corporate Stock
July 26, 2011
In 2001, the Nevada legislature passed laws making the charging order the exclusive remedy of a judgment creditor for LLCs and LPs. However, with the passage of Senate Bill 242, the Nevada legislature has gone a significant step further. Effective July 1, 2007, Senate Bill 242 makes the charging order a judgment creditor’s exclusive remedy in actions against debtors’ interests in small corporations. Indeed, with the enactment of this bill, codified at NRS 21.090 and NRS 78.746, Nevada has become the first state to provide small business corporations (including closely-held, family-owned corporations) with the same charging order protection that has been available to LLCs and LPs.
By applying charging order protection to corporate stock, Nevada has considerably enhanced its already strong asset protection laws. Pursuant to Senate Bill 242, a judgment creditor only has the rights of an assignee and is therefore forced to patiently wait for distributions (if any) to be made from the charging order protected Nevada corporation to satisfy its judgment. Indeed, a judgment creditor has no method to force a distribution, exercise managerial or voting rights, or otherwise control the small corporation in any manner.
Nevertheless, the charging order protection provisions of Senate Bill 242 do not apply to all Nevada corporations. Rather, the stock of a Nevada corporation will be exempt from execution only if the following requirements are satisfied:
1. The corporation has more than 1 but less than 100 stockholders of record at any time;
2. The corporation is not a subsidiary of a publicly traded corporation, either in whole or in part; and
3. The corporation is not a professional corporation as defined in NRS 89.020.
In addition, the charging order provisions do not apply to any liabilities of a stockholder that existed as the result of an action filed before July 1, 2007.
Whether you are a Nevada resident or live elsewhere, Nevada’s charging order protection for small corporations poses a substantial legal hurdle for a creditor to overcome. Since obtaining a charging order (and thereby only a right to distributions) is not a very effective remedy for a creditor, corporate debtors will now have negotiating leverage with creditors that could result in a debtor-friendly settlement.
Furthermore, there is a popular belief that, pursuant to Revenue Ruling 77-137, the owner of the charging order will be taxed on the income attributable to the charged interest regardless of whether the entity actually distributes any of its income. While many practitioners are not of the belief that Revenue Ruling 77-137 stands for the proposition that the creditor will need to pay taxes on phantom income, the threat alone of “KO by the K-1” can be enough to convince a creditor to accept a settlement favorable to the debtor.
Therefore, even if you are a non-resident of Nevada, the costs of setting up this legal hurdle (e.g., the annual cost of the registered agent) are generally inexpensive when contrasted with the potential benefits of an out of state judge applying Nevada’s unique corporate charging order protection law.