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What Makes Delaware LLCs So Much More Popular Than Corporations and LLCs from Other States?

By IncNow | Published March 24, 2017

LLC vs IncIn order to explore what makes corporations and LLCs different, it is important to first note the one primary way in which they are similar: both have a barrier that prevents business debtors from collecting against the personal assets of an owner. This means the owners’ personal assets are not available for collection by a creditor of the company to satisfy a debt of the company, because the owner is not a proper party to a collection lawsuit brought by a business creditor. This shield protecting the owner is known as the “veil,” and in Delaware, the corporate or LLC veil is nearly impenetrable and is the “traditional shield” of limited liability.

LLC Charging Order: Two-Way Protection                                                                     

Unlike many other states, one key benefit of the Delaware LLC not available to corporations in any state is that the Delaware LLC also offers a second type of protection: the “reverse shield.” Choosing to form a Delaware LLC creates a two-way shield. Unlike the traditional shield, the reverse shield reciprocally protects creditors of the owner from controlling or liquidating the assets of the LLC. The Delaware LLC limits a creditor of an LLC’s member to a “charging order” being the creditor’s exclusive remedy at law. This limits a hostile creditor of a member to only a lien against the financial profits actually distributed to the debtor owner up until the lien is paid off without the right to vote, manage, or liquidate the LLC in the interim. Therefore, unlike in many other jurisdictions, a hostile creditor of a member cannot itself take over the ownership interest. The creditor of a member holding a charging order only receives an economic interest without voting rights.

One policy reason to support this result of additional limited liability protection under Delaware law is that the Delaware LLC Act clearly supports the maxim that owners should be able to “pick their partners,” because a hostile creditor would be an unwelcome LLC member and not part of the bargain the members agreed to when organizing the company. While some other states support this policy to a degree, Delaware even extends its charging order protection beyond multi-member LLCs to include single-member LLCs with no other partners. To many, this is astonishing that this protection also extends to LLCs with only one owner, provided it is formed in Delaware. This charging order remedy prevents even a single-member LLC owner’s hostile personal creditors from attempting to control or liquidate the LLC’s assets. Thus, the Delaware LLC provides the greatest protection by shielding personal creditors from either owning or controlling the LLC’s assets.

Corporations: One-Way Protection

In contrast, corporations only provide one type of asset protection, the traditional shield. A corporation only protects each shareholder’s personal assets from company liabilities, there is no reverse shield as would be provided by the Delaware LLC. Unfortunately corporations allow a shareholder’s hostile personal creditor to foreclose on the debtor’s stock and stand in the shoes of the shareholder. This can spell disaster for the single stockholder corporation who may lose all stock ownership and control to a personal creditor. Likewise, this would be a disaster for the remaining stockholders in a multiple owner corporation who are then surprised and subject to the whims and short-term self-interest of an outsider gaining ownership and control of a fellow business partner’s stock with a goal to liquidate or takeover the corporation.

Why Delaware Business Laws are Better

How does Delaware make laws that are so business-friendly? Delaware corporate and LLC statutes are enacted by the Delaware General Assembly. The Delaware General Assembly has a tradition of deferring to the Delaware State Bar Association to suggest changes to and new corporate and LLC laws. Plus modifications to the corporate laws can only be enacted by a super majority of the Delaware General Assembly to ensure more stability. This creates a more expert-driven drafting process where the Delaware corporate and LLC lawyers who practice and focus on those areas of law are often the ones drafting and circulating for comment proposed changes through a committee structure designed to balance the interests of owners and managers of businesses. This process keeps Delaware’s statutes on the cutting edge of LLC and corporate law in the United States.

Delaware Courts: Business Expert Judges

The reason other states cannot “match” the advantages of the Delaware LLC Act simply by replicating their statutes to match Delaware statutes is because Delaware also has a court system to enforce these rights and the internal organizational documents of the LLC in a predictable manner. Delaware has a Court of Chancery with a Chancellor, Vice Chancellors and Masters who are politically balanced and selected by the Governor for their expertise in business law. These judges have broad equitable powers to decide cases and craft remedies which are balanced in weighing the interests of the litigants. These judges also write reasoned opinions that are thought so highly of that they are the bedrock for corporate and LLC law nationwide. These judges have a reputation for enforcing the LLC Agreement as written and as intended so that business owners have predictable outcomes. Other states cannot match this unique judicial system advantage. Instead, most other states have generalist judges or elected judges without business expertise and whose states have a shallower and less developed body of case law upon which to cite in state court opinions.

LLC Uses: You Name It

In addition to investment real estate ownership, LLCs have become extremely popular for running active businesses. The flexible contract-based Delaware LLC can be custom-fit to the owner’s needs in what is known as private ordering of the LLC’s affairs. While corporate codes are written in mandatory terms of “must,” the Delaware Limited Liability Company Act largely uses enabling terms of “may.” This critical difference leaves the vast majority of decisions of planning how to organize the LLC’s ownership and management up to the business owners to decide at the outset and describe in their own custom-crafted LLC Operating Agreement, which provides for maximum freedom of contract in setting up the business as they deem appropriate without limitations.

LLC Operating Agreement: Contractual Freedom to do What You Want

Many believe that the Delaware LLC is superior to corporations because an LLC is governed by an Operating Agreement drafted to match the owners’ exact business interests, setting forth the relationship of control, management and financial interests of its business partners. Corporations have strict management and ownership rules created by statute, many of which cannot be modified by owners no matter how they would prefer to structure the business. This Delaware LLC Operating Agreement can anticipate member disputes and function like a prenuptial agreement to avoid litigation in the case of a “business divorce,” and many other major events in the life span of a company, making the Operating Agreement’s function in running the LLC all the more valuable. Even with a separate stockholder agreement, a corporation cannot achieve all of the benefits of a Delaware LLC’s Operating Agreement.

Conclusion: Why the Delaware LLC is the Best

Thus, a Delaware LLC with a well-drafted Operating Agreement is often thought superior to any corporation from any state and superior to LLCs from other states, making the Delaware LLC a very popular choice for business formation no matter where a company is headquartered. This is why Delaware LLCs are formed at three times the rate of more restrictive, less protective corporations.

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When deciding where to form your company, consider that Delaware has advantages over your home state that may benefit you. Go