June/July 2014

COMMUNIQUÉ is printed and mailed to all CCBA members. View full-issue (PDF): Communique-JuneJuly2014-Full-Issue

State of Formation: Why does it matter? Cover_Communique-JuneJuly2014

By Brian Blaylock, Esq. and Daniel Kiefer, Esq.

© 2014 This article was originally published in the printed magazine COMMUNIQUÉ, the official publication of the Clark County Bar Association. (June/July 2014, Vol. 35, Nos. 6-7). All rights reserved. For permission to reprint this article, contact the publisher Clark County Bar Association, Attn: COMMUNIQUÉ Editor-in-Chief, 725 S. 8th St., Las Vegas, NV 89101. Phone: (702) 387-6011.

Forming a new business entity has never been easier. States across the country have increased both the standardization of organizational documents and the efficiency with which such documents are filed. This has resulted in more and more entities being formed without the advice or aid of an attorney specializing in business law. Given the actual and perceived costs associated with obtaining legal counsel, this result is understandable. As attorneys, however, we should not forget that, no matter how simple the underlying procedures become, the formation of a new business entity remains a legally significant act.

Each entity formation is the product of a series of implicit decisions, even the most fundamental of which carries important legal consequences and should be made in light of relevant considerations. Every time a legal entity is created, a state of formation is chosen. When clients form entities on their own, however, they may select a state of formation without a basic understanding of the related legal consequences. Some, for example, may be inclined to form Delaware entities based on a vague (albeit highly publicized) notion that Delaware’s laws are “pro-business.” Yet, if such clients act without knowing how Delaware’s purportedly “pro-business” laws will actually affect their entities, they may be choosing a catchphrase, rather than a state of formation.

This article reviews certain considerations that are relevant when selecting a state of formation for a proposed entity. While a comprehensive list of every potentially relevant consideration when choosing a state of formation cannot be addressed, the considerations included are important and broadly applicable. They therefore remain relevant, even if other considerations outweigh them under certain circumstances.

When deciding on a proposed entity’s state of formation, it is important to consider the effect that decision will have on the entity’s internal matters, its interactions with third parties, and its interactions with state governments.

Internal matters

One of the most important considerations when choosing a proposed entity’s state of formation is the impact of the internal affairs doctrine – a long-standing choice of law principle that both federal and state courts apply in corporate disputes. In CTS Corp. v. Dynamics Corp. of America, the Supreme Court of the United States stated that it is “an accepted part of the business landscape in this country for States to create corporations, to prescribe their powers, and to define the rights that are acquired by purchasing their shares.” 481 U.S. 69, 91 (1987). The Court further recognized that each “State has an interest in promoting stable relationships among parties involved in the corporations it charters, as well as in ensuring that investors in such corporations have an effective voice in corporate affairs.” Id. As the Delaware Supreme Court later explained, “[t]he internal affairs doctrine . . . recognizes that only one state should have the authority to regulate a corporation’s internal affairs – the state of incorporation.” VantagePoint Venture Partners 1996 v. Examen, Inc., 871 A.2d 1108, 1112 (Del. 2005).

The internal affairs doctrine developed on the premise that, in order to prevent corporations from being subjected to inconsistent legal standards, the authority to regulate a corporation’s internal affairs should not rest with multiple jurisdictions. It is now well established that only the law of the state of incorporation governs and determines issues relating to a corporation’s internal affairs. By providing certainty and predictability, the internal affairs doctrine protects the justified expectations of the parties with interests in the corporation.

Id. at 1112-13 (citations omitted).

Under the internal affairs doctrine, the laws of the state of formation govern the relationships among or between the entity, its owners, and its management. Thus, by choosing to form an entity in a given state, one also chooses the laws that will govern matters ranging from the voting rights of the entity’s owners and the fiduciary duties of its management (including the enforceability of any purported waivers thereof) to the effectiveness of any anti-takeover provisions in the entity’s governing documents. As a result, when a state is touted (or denounced) as being a “corporate haven,” more often than not, the commentator is referencing an effect of the internal affairs doctrine.

Interactions with third parties

The internal affairs doctrine does not apply where the rights of third parties external to the entity are at issue. Id. at 1113 n.14. As a result, forming an entity in a given state does not guarantee that the chosen state’s laws will govern the entity’s contract and tort disputes with unrelated third parties. Yet, forming an entity in a particular state can have at least two legally significant consequences with respect to the entity’s third party interactions.

First, by virtue of having been formed in a given state, the entity is domiciled in that state. Accordingly, the entity is automatically subject to general personal jurisdiction in its state of formation. Consequently, if the entity is later sued in its state of formation and moves for dismissal of the action based on a lack of personal jurisdiction, the entity’s motion will most likely be denied, even if the conduct underlying the suit took place elsewhere and the entity’s owners, management, and operations are all located in another state.

Second, while forming an entity in a particular state does not, in itself, guarantee that the law of the state of formation will govern the entity’s contractual dealings with third parties, it can increase the likelihood that a court will enforce a choice-of-law provision that selects such state. In Nevada, for example,

[i]t is well settled that the expressed intention of the parties as to the applicable law in the construction of a contract is controlling if the parties acted in good faith and not to evade the law of the real situs of the contract. Under choice-of-law principles, parties are permitted within broad limits to choose the law that will determine the validity and effect of their contract. The situs fixed by the agreement, however, must have a substantial relation with the transaction and the agreement must not be contrary to the public policy of the forum.

Ferdie Sievers & Lake Tahoe Land Co., Inc. v. Diversified Mortgage Investors, 603 P.2d 270, 273 (Nev. 1979) (emphasis added) (citations omitted).
As explained above, each entity is a domiciliary of its state of formation. Consequently, a Nevada court is more likely to enforce a choice-of-law provision that selects an entity’s state of formation because the entity’s corporate citizenship is, itself, evidence of “a substantial relation with the transaction.”

Interactions with state governments

In addition to the foregoing considerations relating to internal matters and third party interactions, choosing a proposed entity’s state of formation affects nearly every subsequent interaction the entity will have with state governments. First and most fundamentally, only those entity types specifically authorized under a given state’s laws may be formed within that state. Thus, by choosing a state of formation, one also chooses exactly which types of entity one may form. This consideration may at first seem too simple to merit mention. However, more than one attorney has been asked to assist a client with forming a series limited liability company in California or Arizona (both currently impossible) or a low-profit limited liability company (an L3C) in Nevada (also impossible). When a client requests a state and entity combination such as these, an attorney should begin by explaining the underlying legal principle that renders such a combination impossible – only those specific entity types authorized under a given state’s laws may be formed within that state. Then, after independently assessing the client’s situation, the attorney can advise the client of the best available alternative to address the client’s needs – whether by selecting a different state, a different entity type, or an entirely different combination thereof.

Once the client has agreed to an alternative combination, the chosen state’s laws will also dictate the procedures necessary to form and later maintain the entity. With respect to formation, such procedures include the required form of the entity’s organizational documents, the fees associated with filing such documents, and the manner in which such documents must be filed. Thereafter, the chosen state’s laws will govern the procedures necessary to maintain the entity, including the amount and frequency of any recurring fees, the content of any required reports, and any other ongoing obligations, such as maintaining a registered agent or office of record within the state.
Finally, an additional consideration, also governed by the laws and administrative policies of the state of formation, is the degree to which information regarding an entity (such as its ownership structure and organizational documents) is made publicly available and, if made publicly available, the degree to which such information is widely disseminated (for example, on a secretary of state’s website). For a variety of reasons, the relative privacy offered by certain states can be, for some clients, a very important consideration. As a result, attorneys who familiarize themselves with various states’ laws and policies regarding the public disclosure of entity information will be better equipped to advise clients when deciding in which states to form their entities.

In conclusion, while choosing a proposed entity’s state of formation is one of the most basic decisions relating to entity formation, it nevertheless carries important legal consequences for both the entity and its owners. In light of these consequences, as well as those relating to the myriad other decisions implicit in any entity formation, we should always be mindful that, no matter how simple the underlying procedures become, forming an entity remains a legally significant act.

Brian Blaylock and Daniel Kiefer are associates in the Las Vegas office of Lewis Roca Rothgerber LLP. Brian practices in the areas of corporate and real estate transactions. Daniel practices in the areas of commercial litigation and bankruptcy. The authors gratefully acknowledge the research assistance of Laura Guidry, a law student at the William S. Boyd School of Law and 2014 recipient of the UNLV Professional Development Fellowship.

Limited Liability Companies’ Member’s Interests and Charging Orders: Nevada’s Exclusive Remedy for Judgment Creditor

By Elizabeth Sorokac, Esq. and Jacqueline N. Walton, Esq.

© 2014 This article was originally published in the printed magazine COMMUNIQUÉ, the official publication of the Clark County Bar Association. (June/July 2014, Vol. 35, Nos. 6-7). All rights reserved. For permission to reprint this article, contact the publisher Clark County Bar Association, Attn: COMMUNIQUÉ Editor-in-Chief, 725 S. 8th St., Las Vegas, NV 89101. Phone: (702) 387-6011.

The state of Nevada offers many economic benefits for individuals and businesses, including the lack of state corporate and personal income tax, favorable business laws, and other favorable tax benefits for businesses. One benefit of Nevada’s business laws to both individuals and businesses is the charging order remedy. A charging order is a statutory remedy available to a judgment creditor of a member of a Nevada limited liability company (“LLC”) whereby the judgment creditor may seek an order from a court to charge the member’s interest in the LLC with the amount of a judgment. See NRS 86.401(1).

The history of the charging order

Charging orders were originally established by statute to serve as a solution to common law remedies that were not effective in reaching partnership interest. Weddell v. H2O, Inc., 271 P.3d 743, 749 (Nev. 2012), (citing Green v. Bellerive 763 A.2d 252, 256 (Md.Ct.Spec.App.2000)). Originating in England, the charging order concept was first adopted in the United States with the 1914 Uniform Partnership Act. Id.; see also Jay D. Adkisson, Carter G. Bishop & Thomas E. Rutledge, “Recent Developments in Charging Orders,” Business Law Today, February 2013. Since then, the charging order concept has been extended from partnerships to limited liability companies and, in Nevada, to corporations. See NRS 87A.480, 88.535 and 78.746.

Member’s interest in a limited liability company

In 1991, Nevada became the fifth state to officially recognize the limited liability company as a form of legal entity through the adoption of Assembly Bill 655. Weddell, 271 P.3d at 749; see also Keith Paul Bishop & Jeffrey P. Zucker, Bishop and Zucker on Nevada Corporations and Limited Liability Companies, 16.1 & n.7 (2011). An LLC is governed by Chapter 86 of the Nevada Revised Statutes, its articles of organization, and its operating agreement, to the extent one exists. Pursuant to NRS 86.801, a member of an LLC is “the owner of a member’s interest in a limited liability company or a noneconomic member.” A member’s interest is defined as “a share of the economic interests in a limited liability company, including profits, losses and distributions of assets.” NRS 86.091. A member’s interest in an LLC is considered the personal property of the member. NRS 86.351(1).
Subject to the LLC’s articles of organization and operating agreement, members of an LLC are vested with management rights in proportion to each member’s capital contribution to the LLC. NRS 86.291.

Judgment creditors’ rights under a charging order

A charging order is the exclusive remedy for a judgment creditor seeking to satisfy the debt of a member of an LLC, regardless of whether the LLC is a single- or multiple-member LLC. The judgment creditor seeks a charging order from a court and, if issued, the charging order directs the LLC to make distributions directly to the judgment creditor that would otherwise be made to the debtor member. Specifically, NRS 86.401(1) provides:

On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the member’s interest with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of the member’s interest.

A charging order does not allow the judgment creditor to reach the LLC’s assets or step into the member’s shoes, as the judgment creditor only has the rights of an assignee of the member’s interest through the charging order. Weddell, 271 P.3d at 749-50; see also NRS 86.401(1); Green, 763 A.2d at 259. Upon the issuance of the charging order and as an assignee of the member’s share of the profit of the LLC thereunder, the judgment creditor is not entitled to participate in the management of the LLC nor does it obtain any interest in the assets of the LLC through the charging order. On the other hand, the debtor member no longer has any rights to distributions from the LLC (due to the charging order), but the debtor member does retain all other rights as a member, including the right to continue managing the LLC, if applicable. Weddell, 271 P.3d at 750.

Nevada Revised Statute 86.401(2) specifically provides that no other remedy is available to the judgment creditor in its efforts to satisfy an unsatisfied judgment against a member with the debtor’s member interest. This exclusion includes, but is not limited to, the foreclosure on the member’s interest by the judgment creditor that is successful in obtaining a charging order.

Practice tips

Determination of governing law. Not all states offer the same protections as Nevada to those with member interests in an LLC. For example, some states’ statutes allow the foreclosure by the judgment creditor on a member’s interest while others do not expressly provide a charging order as the judgment creditor’s exclusive remedy. Thus, organizing in Nevada is the first step toward protecting the LLC from other individuals or entities (other than the chosen members of the LLC) in exerting ownership or management rights in the LLC.

Bankruptcy. One note of caution is that in the bankruptcy context, state law does not control if the Bankruptcy Code directs a contrary outcome. See, e.g., In re B&M Land and Livestock, LLC, 498 B.R. 262 (2013) (concluding that where a debtor has a membership interest in a single-member LLC and files for bankruptcy, the trustee’s rights include the right to manage the entity).

Drafting agreements to address the charging order. In drafting an LLC’s operating agreement, it is important to consider whether to include provisions in anticipation of a charging order, such as an involuntary transfer provision (where the other members of an LLC may purchase the debtor’s member’s membership interest upon the issuance of a charging order) or an automatic dissolution clause (whereby the LLC automatically dissolves upon the issuance of a charging order). Further, provisions of NRS 86.401 do not supersede any agreement between the judgment creditor and the member. The judgment creditor and member may negotiate an agreement for the payment of the debt, which may include the sale of the debtor member’s membership interest. However, clauses in operating agreements limiting and/or restricting a member’s ability to transfer or sell its membership interest are common and must be considered in any agreement regarding the payment of the judgment.

Alternative entities. Other forms of legal entities offer similar protections to an LLC, including the lack of availability of equitable remedies (i.e., charging order exclusive remedy). However, in the case of a corporation, the alter-ego doctrine may be available under certain circumstances. See NRS §78.746.

Elizabeth M. Sorokac is an owner and founding member of Reisman Sorokac. She has been practicing in Las Vegas since 2001. Her practice focuses on real estate, government affairs, administrative law, and corporate matters. She can be reached via phone at (702) 727-6258 or via email at esorokac@rsnvlaw.com.

Jacqueline N. Walton is an associate at Reisman Sorokac. She practices in the areas of real estate law, corporate matters, and government affairs. She can be reached via phone at (702) 727-6258 or via email at jwalton@rsnvlaw.com.

The Nightmare of Going Backwards

By Allyson R. Noto, Esq.

© 2014 This article was originally published in the printed magazine COMMUNIQUÉ, the official publication of the Clark County Bar Association. (June/July 2014, Vol. 35, Nos. 6-7). All rights reserved. For permission to reprint this article, contact the publisher Clark County Bar Association, Attn: COMMUNIQUÉ Editor-in-Chief, 725 S. 8th St., Las Vegas, NV 89101. Phone: (702) 387-6011.

By now some, but not all, of the dust has settled from the whirlwind of confusion created by the Nevada Legislature’s revisions to Nevada’s Anti-Deficiency laws in 2011. However, the effect of the legislation and the uncertainty that remains as a result of the Nevada Supreme Court decision in Sandpointe v. Dist. Court, 313 P.3d 849 (2013) are issues that all Nevada businesses, and those contemplating doing business in Nevada, should consider.

In light of the Nevada Legislature’s intentional, retroactive impairment of lenders’ substantive, contractual rights, it is no longer certain that parties contracting in Nevada may rely on the laws in existence at the time of the execution of their contract or that our Legislature will protect the sanctity of those contractual rights. While the Contracts Clause of the U.S. Constitution mandates that “[n]o State shall . . . make any law impairing the obligation of contracts.” U.S.C.A. Const. Art. 1, §10, our legislature has materially, and retroactively, diminished the rights of parties acquiring negotiable instruments secured by real property and our Supreme Court has declined to pass on the constitutionality of that impairment.

The drafters of the revision to the Anti-Deficiency Statutes were cognizant of, and indeed concerned about, how their proposed changes could negatively affect existing contract rights. During the 2011 legislative session, the following colloquy occurred:

Assemblyman Conklin:
There is no retroactivity in this bill. It is simply all future action. We could debate this, but the retroactivity issue is a matter of contract . . . . Business does not want to operate in an environment in which laws are changed to favor one or the other party after they enter into a contract. While on one hand it may be nice to retroactive a law, the precedent it sets is enormous and probably highly detrimental to the business environment of Nevada.

Chair Atkinson:
I agree with that assessment. I wanted to ensure we had that on the record because I know it came up. I think it would be a nightmare to go backwards. I appreciate that and your work.

Minutes of the Meeting of the Assembly Committee on Commerce and Labor, March 28, 2011, pgs 12-13.

Despite the foregoing, the Nevada Legislature – by and through an Amicus Brief filed by the Legislative Counsel Bureau, affirmatively represented that the revisions to Chapter 40 were intended to operate retroactively. In other words, that the changes in the statutory scheme were intended to alter and diminish the fundamental rights of assignees of negotiable instruments secured by real property. This pronouncement is alarming as it demonstrates that our legislature will disregard the settled expectations of parties to a contract.

The issues remaining post-Sandpointe

In the two years following passage of AB 273, attorneys for creditors and borrowers litigated the language and intent of the new legislation – each arguing that the ambiguities of the revisions militated opposite conclusions. While the legislature had the opportunity to settle the debate, and, in fact considered amending the statute in the 2013 session, it declined to act effectively deferring the interpretation to our Supreme Court.

In Sandpointe, the Supreme Court of Nevada, held that NRS 40.459(1)(c) applies only to a deficiency claim where the foreclosure occurred on or after the effective date of the revisions to the statute. The Court noted that, for purposes of applying NRS 40.459(1)(c), a holder of a promissory note and deed of trust “may transfer that right to obtain a deficiency judgment as a bundle of rights secured in a promissory note and deed of trust.” Thus, the Court recognized the right to a deficiency judgment is one of the “bundle of rights” a creditor has and may transfer pursuant to an assignment, but further held that right to be inchoate until a foreclosure sale is concluded. By characterizing the right to obtain a deficiency judgment as an inchoate right, the Court had little difficulty applying the statutory limitation to foreclosures that occurred post enactment. Accordingly, if the note holder aggressively pursued its real property collateral and foreclosed, the note holder is immune from the new statutory limitations on recovery. Counter-intuitively, this distinction punishes the note holder that, despite the right to foreclose, agreed to forbear from foreclosing- a result that is seemingly at odds with the stated public purpose of the statutory revisions ostensibly designed to foster negotiations between the note holder and borrower.

Importantly, the revisions to the statute, and the Court’s recent interpretation, sets the law of assignment on its ear. An assignment of an obligation does not diminish or alter the fundamental, attendant rights transferred. As the United States District Court for the District of Nevada made clear in Interim Capial v. Herr, 2011 WL 7047062, it is well-established that an assignee “stands in the shoes” of an assignor and succeeds to all rights of the assignor. The revisions materially alter and diminish the assignee of a negotiable instrument’s fundamental and statutory rights without a concomitant revision to the Uniform Commercial Code (NRS 104.3203). To retroactively eviscerate an assignee’s fundamental rights by changing the law is exactly the type of “dangerous precedent” the legislature sought to avoid. The answer to Assemblyman Conklin’s rhetorical question: “if that were done, who would ever want to sign a contract or do business in a state that would nullify contracts” remains pending.

The “nightmare of going backwards” that Chair Atkinson articulated has, in fact, been realized. Sale and assignment of notes secured by real property consummated prior to the enactment of the revisions included the associated rights to enforce the obligations and, if appropriate, obtain a deficiency judgment against the borrower and guarantor. Despite the expectations of the parties to those assignments, to the extent that the note holder failed to foreclose prior to the effective date of the revisions, their bargained for right to recover a deficiency has been substantively altered and may well be extinguished altogether. This application has resulted in the articulated scenario that the Legislature said it was trying to avoid – a dangerous precedent for individuals and businesses that enter into contracts in Nevada as now “they will have to wonder how the contract can be enforced or how it can be changed.” Minutes of the Assembly, March 23, 2011.

Federal court ruling post-Sandpointe – some relief

In a recent, post-Sandpointe case the United States District Court for the District of Nevada, the Court looked at the issue of whether the application of NRS 40.459(1)(c) to mortgages assigned before the effective date of the statute would violate the Contracts Clause of the United States Constitution, regardless of when the foreclosure sale took place. Eagle SPE NV I, Inc, v. Kiley Ranch Communities et al, F.Supp. 2d (2014).

The Court found that NRS 40.459(1)(c) “cannot constitutionally apply to assignments made before the statute’s effective date.” Judge Jones opined it is “clear that the statute substantially impairs any existing assignment by reducing the amount an assignee can recover on debt he already purchased under a legal regime where his potential recovery was not limited by the amount he paid for the debt, and without any refund or other benefit offsetting the loss in value.” Id. at *7.

The Court determined that the amended statute, if retroactively applied, provides “a windfall to a particular class (mortgagors) that could not have been reasonably expected under the mortgage and assignment when made, to the detriment of another distinct class (mortgage assignees).” Judge Jones astutely recognized that the State’s impairment of contracts under the revised statute “creates an unexpected windfall as opposed to avoiding one.”

Judge Jones was emphatic in his opinion that the application of the statute to pre-enactment assignments “does nothing to further the purposes of encouraging negotiations between mortgagees and mortgagors, because pre-enactment assignees had no reason to think that the value of their contracts would be limited when they purchased mortgages before the law took effect.” Id. at *12 (Emphasis in the original).

Judge Jones further recognized that an application of the statute to assignments of mortgages would mean that the assignees would face an unexpected, retroactive destruction of the value of their contracts. His thoughtful and thorough decision recognizes that the obligations of an assigned contract must be enforced in its full obligatory scope. Otherwise, the contract, “ceases to be, and falls into the class of those ‘imperfect obligations’ . . . which depend for their fulfillment upon the will and conscience of those upon whom they rest.” Id. at *10.

In Nevada, businesses must be able to rely on the enforcement of the obligations for which they bargained.

Effect of a retroactive application of NRS 40.459(1)(c)

The chilling effect in our State related to any retroactive application of NRS 40.459(1)(c) must be considered. The secondary market for assets of failed institutions, or for banks that are trying to raise capital, will be chilled because successor creditors will now be limited to only recovering what they paid. As Judge Jones pointed out in Kiley Ranch, “an assignee who purchases a defaulted mortgage under the amended statute can only profit thereby if the value of the security is greater than the price of the assignment plus the costs of foreclosure.”

The Court concluded that “no rational lender” will sell the mortgage at such a price in the first place. As buying and selling mortgages are an integral part of the banking industry, such a chilling effect will surely be felt across the state.

The broader implication of the statutory amendments is potentially more profound. As the Supreme Court of the United States has recognized laws are subject to constitutional scrutiny because without it, contracts “are reduced to simple, unenforceable promises.” General Motors v. Romein, 112 S. Ct. 1105, 117 L.Ed. 328 (1992). Contracts enable individuals “to order their personal and business affairs according to their particular needs and interests. Once arranged, those rights and obligations are binding under the law, and the parties are entitled to rely on them.” Allied Structural Steel Co. v. Spannaus, 438 U.S. 234, 245, 98 S. Ct. 2716, 57 L. Ed 2d 727 (1978). All parties contracting in Nevada, or considering contracting, may be legitimately concerned with how our legislature views the rights of contracting parties in this state.

While the limitations imposed by NRS 40.459 relate only to actions for deficiencies, it would be myopic to believe that the above referenced statutory changes have no implication on business as a whole in Nevada. To the contrary, the willingness and intent of the legislature to impair existing contractual rights sends a message that it may, in the future, reduce other contracts to a simple, unenforceable promise.

Allyson R. Noto is a partner at the law firm of Sylvester & Polednak, Ltd. She is a commercial litigator representing both lenders and borrowers. Ms. Noto also represents clients in a variety of business related disputes and general civil litigation matters.

Expanding Your Dispute Resolution Toolkit with Collaborative Law

By Glenn Meier, Esq.; Gina Bongiovi, Esq.; and Shan Davis, Esq.

© 2014 This article was originally published in the printed magazine COMMUNIQUÉ, the official publication of the Clark County Bar Association. (June/July 2014, Vol. 35, Nos. 6-7). All rights reserved. For permission to reprint this article, contact the publisher Clark County Bar Association, Attn: COMMUNIQUÉ Editor-in-Chief, 725 S. 8th St., Las Vegas, NV 89101. Phone: (702) 387-6011.

You’ve no doubt heard the expression, “If all you have is a hammer, every problem looks like a nail.” This expression can be very instructive for lawyers whose work involves helping clients resolve disputes. The traditional way attorneys have done so is through litigation, which is most certainly the “hammer” of dispute resolution tools. These days, however, many business clients find that they cannot afford the money or the time needed to hammer away at their disputes. More and more business clients are looking to their lawyers to show them different tools to use with their disputes. One tool that all business lawyers should look to add to their toolkits is collaborative law.

What is collaborative law?

Collaborative law is a dispute resolution technique that empowers parties to a dispute and allows them both the ability and the responsibility to work together and craft their own solution to their conflict. Collaborative law means that all parties to a dispute and their lawyers work together to achieve resolution.

The process begins with all parties and their lawyers entering into a participation agreement. This agreement states the parties’ intention to work together to resolve an existing dispute. A key feature of the participation agreement is the withdrawal provision, which states that if the parties cannot resolve their dispute collaboratively and move into litigation, then the collaborative lawyers will withdraw from further participation in the case. This provision works to align the interests of the parties and the lawyers and provides strong incentive to work through the challenges of the collaborative process. The clients know that if they decide to abandon collaboration and move to court, they will need to retain new counsel and will incur significant additional costs for the new lawyers to get up to speed. Thus, the collaborative lawyers’ interests in maintaining business are now also aligned with the clients’ interests in achieving resolution.

After the agreement is in place, the parties will embark on a course of negotiation and joint problem solving to work towards the resolution of their dispute. During this time, the clients are actively involved in working with the lawyers to develop solutions. If the parties find themselves needing more information, then additional experts can be included in the process. For example, business partners in a dispute may need additional information about the financial state of their company. Under the collaborative model, the parties would retain a joint expert to examine and report on the company’s finances. Ultimately, the goal of the collaborative process is to find mutually agreeable resolutions that serve the interests of all parties.

What rules govern collaborative law?

In 2011, to help facilitate the practice of collaborative law, the Nevada State Legislature passed AB91, which adopted the Uniform Collaborative Law Act (“UCLA”). The bill passed with unanimous votes in both the assembly and the senate and went into effect on January 1, 2013. The UCLA is found at NRS 38.400 et seq. The UCLA contains several provisions on various procedural aspects of the collaborative law process, including how the collaborative law process works in a case with litigation already pending. In such a case, the parties file with the court a notice of their entry into a collaborative process. That notice acts as an application for a stay of litigation. See NRS 38.495. The UCLA also specifies a fairly broad privilege for collaborative law communications. See NRS 38.545 to 38.560.

Additionally, the UCLA codifies several core principles unique to collaborative law. For example, NRS 38.510 states that if the collaborative process terminates and the case moves in to litigation, the collaborative lawyers will be disqualified from representing the clients in any litigation related to the collaborative process. Again, this provision helps all parties stay invested in moving the collaborative process towards final resolution.

Nevada Revised Statute 38.525 requires all participants in a collaborative process to respond to requests for information with “timely, full, candid and informal” disclosure of information related to the process. Full and candid disclosure is a critical component to the collaborative process.

Meanwhile, NRS 38.535 requires lawyers to advise prospective collaborative law clients about certain aspects of collaborative law and also requires the lawyer to work with their prospective client to determine whether collaborative law is an appropriate process for that particular client. This requirement recognizes that, while collaborative law is a powerful dispute resolution tool, it is not appropriate for every dispute. The assessment ensures that lawyers will work with prospective clients to confirm whether collaborative law is right for that particular client.

Section 38.530 of NRS states that the UCLA will not affect, “[t]he professional responsibility obligations and standards applicable to a lawyer or other licensed professional.” This provision highlights how the practice of collaborative law integrates with the rules of professional conduct. The ABA Standing Committee on Ethics and Professional Responsibility addressed this issue several years ago when it issued Formal Opinion 07-447. The principal ethical issue in that opinion is whether the lawyers commitment to withdraw from representation if the collaborative process terminates creates a conflict of interest arising out of an obligation to a third party, as described in NRPC 1.7(a)(2).

The ABA opinion noted that, while several state bar opinions at that time had analyzed collaborative practice and concluded it was not inconsistent with the rules of professional conduct, the Colorado state bar had concluded that a participation agreement including a withdrawal or disqualification provision created a non-waivable conflict under Rule 1.7. See Colorado Bar Ass’n Eth. Op. 115 (Feb. 24, 2007). The ABA opinion determined that, while a participation agreement does contain obligations to one or more third parties, the obligation does not create a conflict of interest because, with proper advance disclosures, a collaborative law engagement constitutes a reasonable limited scope engagement between lawyer and client pursuant to Model Rule 1.2(c). See ABA Opinion 07-447 at 3-5. As Nevada’s Rule of Professional Conduct 1.2 mirrors the relevant provision of the ABA model rule, the ABA opinion makes a persuasive case for collaborative practice in Nevada being consistent with the ethical obligations of Nevada lawyers.

Why is collaborative law good for business clients?

Collaborative law can be a powerful tool for dispute resolution, particularly when the disputing parties need to maintain an ongoing relationship. Litigation has the potential to be very destructive due to the high costs both financially and emotionally. Since the collaborative process involves people working together, it can actually strengthen the relationship between the parties. In addition, the collaborative process can be much more efficient, saving people time and money.

In a situation familiar to one of the authors, a customer ordered promotional products from a supplier for a big event. Due to delays on the manufacturer’s side, the supplier managed to deliver the products less than 24 hours before the event. The products were all wrong, in that the logo was skewed, the colors were reversed, and the quantity of t-shirts was incorrect. With no time to correct the problem before the event, the customer sought a refund from the supplier. The supplier’s third-in-command took a hard line and refused to refund or even negotiate, forcing the customer to file suit. When the customer’s lawyer contacted the supplier’s CEO with a collaborative approach, the matter was resolved quickly to everyone’s satisfaction (except the third-in-command) and the relationship continues to this day in large part due to the collaborative approach taken by the customer’s lawyer.

Almost any lawyer practicing business law has at one time or another handled a “divorce” between business partners. Partnership divorces can often be as emotionally and financially devastating as spousal divorces. When business partners disagree and cannot resolve their dispute, a lawsuit will almost certainly lead to the company’s collapse. In another situation handled by one of the authors, two partners began to increasingly disagree on important business issues. Initially, the partners disagreed about the type of coffee in the breakroom. Then, there was disagreement on whether to hire another assistant. When they nearly came to blows over how to structure a proposal for a big opportunity, the company’s attorney and CPA staged an intervention. Everyone was put in the same room, were explained the detrimental effects of a lawsuit, and got to the bottom of the issue, which had very little to do with the business itself. One partner was going through a divorce and, feeling like he lost control over his personal life, felt the need to exert more control over the company. With that awareness, which would never have come about through litigation, the partnership was set back on track.

While the above examples did not involve a formal collaborative process under NRS Chapter 38, they are examples of the types of business disputes that are excellent candidates for resolution using collaborative methods. In thinking about the last knock down, drag out business litigation you went through, ask how did the clients come out the other end? How much time and energy was drained from the business to support the litigation and did the company get a good return on its investment of those costs? If your answer to those questions involve a client that was less than satisfied, then you should give strong consideration to adding collaborative practice to your dispute resolution toolkit.

Glenn Meier is a founding partner of the firm Meier & Fine, LLC, with over 20 years of experience practicing in the litigation and dispute resolution areas. He also acts as a mediator and arbitrator in a wide variety of civil cases. Glenn can be reached at (702) 673-1000.

Gina Bongiovi holds a JD/MBA and is managing partner of Bongiovi Law Firm, a boutique practice serving startups and small businesses with an innovative approach to the practice of law. The firm’s clients benefit from a combination of business education and real-world experience which, together, address all facets of business ownership. Gina can be reached at (702) 485-1200.

Business Life and Death, How Bankruptcy can Make or Break a Business

By Nedda Ghandi, Esq.

© 2014 This article was originally published in the printed magazine COMMUNIQUÉ, the official publication of the Clark County Bar Association. (June/July 2014, Vol. 35, Nos. 6-7). All rights reserved. For permission to reprint this article, contact the publisher Clark County Bar Association, Attn: COMMUNIQUÉ Editor-in-Chief, 725 S. 8th St., Las Vegas, NV 89101. Phone: (702) 387-6011.

Every so often in the news, we hear about a well-known large company filing for bankruptcy, be it an airline, automobile manufacturer, or department store. A common question that arises in the mind of the public is, how can these companies continue to do business after declaring bankruptcy? However, bankruptcy is not necessarily a death knell for a business. Many businesses can successfully reorganize through bankruptcy and emerge in a much healthier position to carry on their operations.

The preliminary decision for a business entity to make that is preparing to enter bankruptcy is whether to file under Chapter 7 or Chapter 11 of the federal bankruptcy code. The result of a Chapter 7 is that the business must liquidate all of its assets and cease operations. In contrast, filing under Chapter 11 allows the business to either liquidate and cease operations or to restructure its debt and continue operations. The latter option, referred to as “reorganization,” can be utilized by businesses that wish to stay in business, and can help them emerge from bankruptcy in a stronger financial position, having paid off their debt entirely, or with a manageable repayment plan over time.

Chapter 7

The result of a Chapter 7 bankruptcy is a liquidation of the business’s assets; the business entity will cease to exist. The owners of the corporation, limited liability company, or partnership do not carry out the process of liquidation themselves. Rather, a bankruptcy trustee is appointed to manage the liquidation of assets and payments to creditors. While this option may be preferable for business owners who simply want to wash their hands of the business, it can be undesirable for other business owners who wish to be involved in the process and have input and control over the sale of the assets and the manner in which they are distributed to creditors. For those business owners, a liquidation under Chapter 11 would be appropriate.

Chapter 11

In a Chapter 11 bankruptcy, the business owners will ultimately choose between reorganization and liquidation. Filing under Chapter 11 provides flexibility for the business owner who is unsure upon entering bankruptcy of whether reorganization is feasible, or if liquidation is the preferable alternative, as the decision does not need to be made at the outset.

After Filing

The immediate and critical effect of filing under Chapter 11 is the imposition of the automatic stay, whereby creditors are prohibited from collecting debts owed them by the business. The automatic stay also precludes secured creditors from carrying out foreclosure proceedings. The relief granted by the automatic stay is not absolute, as creditors may ask the bankruptcy court for relief from the automatic stay on various grounds. The business owner should be aware of this possibility, and be sure to comply with all applicable bankruptcy code provisions so that such a motion is unsuccessful.

One of the major benefits of filing under Chapter 11 is that there is no automatic appointment of a trustee to take control of the debtor, as there is in Chapter 7. Under Chapter 11, the owners of the debtor entity may continue to control the management of the business while it is in bankruptcy as the debtor-in-possession (“DIP”). During bankruptcy, the DIP is permitted to use, sell, or lease its property without prior court authorization if it is in the ordinary course of business. The DIP may pursue obtaining loans while in bankruptcy, and also has the option to assume or reject certain contracts it entered into prior to filing bankruptcy. Thus, the business owners may use bankruptcy to assume favorable pre-bankruptcy contracts and leases, and to cancel unfavorable ones.

Change in Mindset

Business owners must beware that they simply are no longer in complete control of the company. For example, the DIP must seek authorization from the court to conduct transactions outside of the ordinary course of business, or to use cash that is subject to a security interest (referred to as “cash collateral”). Further, principles of the business may be called by a creditor for what is known as a “2004 Examination”, which comprises questioning on the record that is broader in scope than a typical deposition in civil litigation, and is often referred to as an allowed fishing expedition.
It is also important for the business owners to recognize that they are acting in a new role as DIP. Prior to filing for bankruptcy, the management owed fiduciary duties to its equity holders, but the DIP owes fiduciary duties to its creditors as well. Although a trustee is not automatically appointed in Chapter 11, in extraordinary circumstances a creditor may move for the appointment of a trustee to take control of the entirety of the debtor’s operations. To avoid this, the DIP must take special care with regards to any potential conflicts of interest within the business, such as self-dealing transactions or insider loans.

The Plan

The crux of a Chapter 11 bankruptcy is the plan, which governs how the debtor’s creditors are to be paid. The plan must be described in a disclosure statement, which the bankruptcy code mandates contain various myriad disclosures, including insider payments to the owners or relatives of the business. Business owners should be prepared for the lack of privacy which comes with bankruptcy, as information about the business’s assets, liabilities, and financial affairs must be made public. The plan must ultimately be voted upon by creditors, and often it is beneficial to negotiate with creditors, particularly secured creditors, to provide terms for the resolution of their debt in the plan that will receive their vote. The debtor’s plan may still be confirmed over the dissent of creditors and without the requisite votes, however, it is subject to strict statutory requirements. Failure to have the debtor’s proposed plan confirmed could lead to the confirmation of a creditor’s alternative plan. The business owner should be aware that plan confirmation can be a long process, and may require the debtor to make concessions in order to receive the necessary votes.

Emerging from Bankruptcy

Although many businesses are motivated into bankruptcy as the result of an imminent foreclosure or other collection proceedings, it is important to consider the desired end result for the reorganized business after it emerges from bankruptcy. The particular strategies and methods of restructuring debt need not be determined at the outset of the bankruptcy case, and often change during the pendency of the case once feasibility is examined and the input of important creditors is obtained. Some options for reorganization to consider are downsizing the business, raising working capital for infusion into the business, changing the business model in order to increase cash flow, or of course liquidation and closing the business. An important factor in plan confirmation is the feasibility of the plan, which means that the method of reorganization must be supported by documentation such as financial projections or business plans.

Many business owners may be reluctant to file for bankruptcy, thinking it requires that everything they worked hard to build must cease to exist. While liquidation can be beneficial for a business that is beyond repair, the business may be preserved, its debts may be settled in full or managed through a feasible repayment plan, and the business can continue on from a stronger position than it was in before bankruptcy.

Nedda Ghandi is a partner at Ghandi Deeter Law Offices, located in downtown Las Vegas. Her firm specializes in the practice areas of bankruptcy, business formations and transactions, family law, probate, and guardianship.