Which State’s Law Applies in a Lawsuit?

February 14, 2017 Asset Protection, Business planning, Corporations, Law, Litigation, Real Estate, Small Business Comments Off on Which State’s Law Applies in a Lawsuit?

We frequently hear from clients who have been told by others that they should incorporate in Nevada (or other states outside of their home state) in order to take advantage of their favorable laws.   We have seen many individuals persuaded into incorporating in a state outside of their home, only to complain about the cost and complexity of the structure which ultimately had to be unwound.

This is not to say that incorporating an entity in Nevada or Wyoming should never be considered as part of an asset protection strategy. One primary reason for incorporating a Nevada or Wyoming entity is arguably due to their strong “charging order” protection.   The charging order is a concept protecting an LLC owner who is sued and held liable for something unrelated to and “outside” from the LLC from then being able go and take that LLC interest or the asset held by the LLC.   For example, if you’re cruising on the highway over the weekend and get into a major accident causing serious injuries, the charging order could prevent or hinder the injured plaintiff from seizing your assets held in your LLC.

However, the myth that we often hear from clients is that because states like Wyoming or Nevada have strong asset protection laws, they should take advantage by incorporating these entities into their structure even if they don’t own assets or do business there. What is often omitted from the conversation is whether Nevada or Wyoming law will actually be applied if there is no connection between the lawsuit and Nevada or Wyoming.

Since we are a union comprised of fifty states with different laws, there is an incentive to try and take advantage of states that have more favorable laws. Courts generally discourage this type of “forum shopping” where people try to use the favorable laws of one state even if they have no actual connection with that state.

One of the ways courts deal with these types of cases is by applying a set of rules called Conflicts of Laws. It is an area of the law that allows a state to determine which laws will apply to a case when the laws of multiple states could potentially apply.

For example, lets say a California resident is driving in Nevada on his way to Vegas and collides with a Colorado resident causing catastrophic injuries. Where should this type of lawsuit be filed and which of these three state’s laws should we apply? Because these types of circumstances can be so varied depending on the residency of the parties and the location where the events resulting in a lawsuit occur, it is sometimes difficult to predict where a lawsuit should be and what state’s laws should apply. This is further complicated by the fact that states have different Conflicts of Law rules.

Here are some general rules that courts will usually apply depending on the type of case. Examples include the following:

  1. Personal Injury or Fraud: Generally the law of the state where the wrongful act causing the injury or fraud occurred will be the law that should be applied. For example, if the accident or fraudulent conduct occurred in Nevada, that is an indicator that Nevada law should be applied;
  2. Personal Property (damage or theft): Where the personal property was located when the act causing the theft or damage occurred may determine which state’s laws should apply;
  3. Real estate: The state where the real estate is located will often determine which state’s laws will apply in a dispute relating to real estate;
  4. Contracts: Where the contract was entered or where the principal events necessary to form the contract occurs. Keep in mind that many contracts have provisions governing which state’s laws or courts will be used in the event of a dispute. These types of “forum selection” or “choice of law” clauses are often enforced by courts, unless there is no substantial or reasonable relationship with the chosen state. For example, if you are in California and you enter into a contract with someone else in California and all the activities relating to the contract occur in California, it is unlikely that a California court would enforce a provision that says Delaware law should apply even if you included such a provision in your contract.

These are just some very general guidelines as courts may consider additional factors in any given case. Hence, the outcome in any particular case is often difficult to predict with any consistency.

Therefore, before you decide to set up a structure that includes incorporating in a state which you have little or no connection with, make sure you understand not only the purposes for choosing that particular state, but perhaps even more importantly, its limitations.     Don’t assume that if you incorporate your entity in Nevada, that you will necessarily get the benefit of Nevada’s laws, especially if you do not live in Nevada.

About the author

Lee is an attorney at the California office of Kyler Kohler Ostermiller & Sorensen located in Irvine, California. Lee focuses his practice on real estate and business transactional/ litigation, debtor/creditor law, IRS negotiations, business planning, asset protection and estate planning. Lee’s practice includes advising clients on the formation of business entities, partnerships, and general tax planning relating to business entity formations. Lee also provides advice on structuring real estate investment deals and asset protection issues arising from investments in real estate. He also regularly advises and assists clients in IRS matters including audits, collections, installment agreements and offers in compromise.