When It Comes to Liability, Don’t Take It Personally: Reincorporate in Delaware with a Delaware LLC Conversion
Kevlar, a protective fabric in bullet-proof jackets, has saved countless lives of police officers and military personnel. Kevlar is a DuPont fiber product, invented in Delaware. Delaware has another invention with protective properties in its incorporation laws, which have saved countless business owners from creditors who would have pierced the corporate veil had the judgment debtor company been incorporated in Pennsylvania, California, or other states with weaker corporate protections. Avoid having a corporate veil of Swiss cheese in a state outside Delaware. Planning ahead by wearing a Kevlar jacket can save your life, just like wrapping your business with a Delaware Corporation or LLC can provide a better protective layer to save your personal assets from a corporate creditor’s bullets.
Delaware’s innovators don’t just work in laboratories, they also work in Legislative Hall and courtrooms to craft the most business-friendly corporate and LLC law in the country. That makes Delaware the best state to incorporate in, no matter where your business activities actually take place and no matter where you live. The state where you incorporate governs the internal affairs of your company, including its liability shield. Unlike Delaware, in other states it is easier to attack owners personally for under-capitalization and “alter-ego” theories of liability. Being difficult to hold business owners liable for debts and judgments against the business has led to over one million companies being formed in Delaware, mostly by people from out of state. Delaware has 1,100,000 business entities. This is more business entities than Delaware has people. Changing corporate homes does not require physical presence and intent to remain. An out-of-state corporation or LLC can change its domicile far more easily with an easy and affordable Certificate of Conversion. The reasons a business chooses to move its domicile to Delaware are mainly for the protection of business-friendly laws and the asset protection of a stronger bullet-proof veil of protection.
The main advantage in converting to Delaware rather than dissolving your existing LLC and forming a new one is that all business relationships, existing contracts, age of the business and credit history remain in-tact. If you choose to form a new LLC and dissolve the old one, you are starting anew at the state level. Your contracts will typically have to be re-negotiated or assigned, your business will get a new formation date and you will lose your original company’s credit history. A conversion will not result in capital gains tax and will avoid the need for an asset purchase agreement between your old and new companies.
We hear owners of companies tell us they were not aware of the advantages of forming in Delaware before they decided to form the entity in the state of principal activity, and are deciding they want the advantages of having their company domiciled on paper in Delaware. Most importantly, they do not want to lose their company’s good credit history, date of formation and the prestige garnered by being an older company. Rather than losing this history by forming a completely new entity and purchasing the assets of the old entity, companies almost always see the Certificate of Conversion as the option that makes the most sense for them and their business.
Not all accountants are aware of the protections afforded by Delaware law. Many accountants will suggest you simply form a home-state company, but from a legal perspective, this can be disastrous if (or when) the business goes south. It could result in your personal assets being available to corporate creditors. Instead of following the advice of your accountant, you should follow your attorney’s advice, which is often to incorporate in Delaware.
Occasionally, when a venture capital firm makes an offer to purchase all or part of the interest in a company, it will include a clause in the offer to make the investment conditional on the company’s reorganization into a Delaware entity. One reason why is because Delaware has a very consistent body of corporate and LLC law. The Delaware Court of Chancery is a business court with judges who are experts in business law. Because venture capitalists are often Delaware entities, alignment of organizational structures between investment and investor vehicles and minimizing conflict-of-law issues are accomplished by the internal affairs of both companies being governed by the laws of the State of Delaware.
In addition to converting domicile, Delaware allows a company to convert entity type. For example, we see businesses filing a Certificate of Conversion to convert an LLC into a Corporation. Conversely, we also more frequently see a Certificate of Conversion filed for a Delaware Corporation to become a Delaware LLC. Conversions are often requested by owners of growing businesses who happened to form as corporations before researching the Delaware LLC and later discover the simplicity and security of operating as an LLC.
Changing your corporate home on paper is not limited to the 50 states and U.S. territories. Outside the United States, business owners also frequently move international company domicile to Delaware through a similar process called a “domestication” or “re-domestication”. For example, because Colombia recently blacklisted Panamanian companies, owners of such Panamanian companies could consider re-domesticating their corporate charter to Delaware and then be allowed to do business in Colombia.
Having considered the advantages of Delaware, the next question is when to pull the trigger. The short answer is before the “other guy”. Put on your bullet-proof jacket before the gun fight begins. It is often not until months or years into a business that you discover the advantages of a Delaware LLC. When you come to Delaware, you are choosing the best state to form your business in, with regard to the protection provided by the Delaware Court of Chancery. For most people, a Delaware LLC is the simplest and most versatile entity. Reincorporating in Delaware with a Certificate of Conversion should help protect your personal assets from business creditors in other states where it is far easier to “pierce the corporate veil.” Delaware is so loathe to pierce the corporate veil that statistically you are more likely to be struck by lightning than to have your Delaware corporate or LLC veil pierced. You don’t even need to travel to Delaware or set up an office or bank account in Delaware.
You should pick a sunny day to replace your roof. Similarly, the best time to switch to Delaware is when your business is running smoothly and bullets are not flying. It is easy to file a Certificate of Conversion with minimal cost and virtually no interruption to your business. You will thank yourself later when the bullet-proof Delaware LLC jacket saves your personal assets.