Skip to content

Shell Companies and LLCs

I will be speaking in a national telephone seminar on January 27, 2012 on the topic of shell companies and LLCs.  I hope to cover both the proper and improper uses of shell companies.

So What, Really, Is the Problem?

Reuters has published yet another article  on the ills of corporate-transparency, this time in the state of Nevada.  The authors are using some pretty sloppy logic to make a social point, rather than simply reporting the news.  For example: “the presence of former felons in the business of creating businesses is an extreme example of vulnerability in corporate America.”  Does this mean that if any industry has former felons in it, it is at risk somehow?  If we discover that someone who works for Reuters was convicted of a felony, does that cast doubt on their reporting?  What if it was only a minor traffic conviction?  Where do we draw the line?  Part of the American philosophy  includes permitting people to get on with their lives, rather than continuing to punish them, once they have paid their debt to society.  Here is an excellent article on hiring ex-felons.

The article does, of necessity, admit that this is a minor problem.  It says “most Nevada companies are above-board.  And so are most shell companies.”  But apparently, when a state offers incentives for incorporating there, that attracts some unscrupulous types in addition to the legitimate businesses.  Who knew?  Reuters actually makes the point, in this article, that there are some excellent reasons for wanting privacy, or using shell corporations.  The problem, which they can’t seem to grasp, is that any system which allows the freedom to conduct legitimate business will also be vulnerable to abuse.  But that is the cost of a free society; everyone may act as they please, but some may choose to act against society’s interests.  When that happens, the law punishes them.  But if we criminalize all behavior, we eliminate the good along with the bad.

The thrust of this article seems to be that dishonest people who have been punished for abusing the system may continue to abuse the system even after they are punished.  But the system itself is just fine.  This is
actually a success story, showing that current law enforcement efforts are making serious headway against those who would use shell companies and other legitimate business tools for tax evasion or other criminal  enterprises.  Maybe, instead of trying to over-regulate States’ activities, we just need harsher sentences for parole violators.

LLCs: Shield From Liability or Cloak of Deception?

It is a common misconception that the corporate form will somehow help an owner avoid liability for his own wrongdoing.  This is false.  Corporations (and later, LLCs) were designed partly to protect the owners from liability for the company’s debts.  However, the courts have long recognized that sometimes, it would be unfair, or unjust, to let those behind the company to escape responsibility.

Every state has its own rules for ‘piercing the corporate veil’ or for ignoring the corporate liability shield to hold owners, directors and officers liable for damage caused by the company in certain circumstances.   Wyoming is no different, and since that state’s business laws have received some attention lately, we will focus on Wyoming’s rules.

Wyoming has recognized that “statutes have created the legal fiction of a corporation being a completely separate entity which could act independently from individual persons.  If the corporation were created and operated in conformance with the statutory requirements, the law would treat it as a separate entity and shelter the individual shareholders from any liability caused by corporate action, thereby encouraging investment.”  Kaycee Land and Livestock v. Flahive, 46 P.3d 323 (Wyo 2002).  However, “when corporations fail to follow the statutorily mandated formalities, co-mingle funds, or ignore the restrictions in their articles of incorporation regarding separate treatment of corporate property, the courts deem it appropriate to disregard the separate identity and do not permit shareholders to be sheltered from liability to third parties for damages caused by the corporations’ acts.”  Id.

In Wyoming, LLC veil piercing factors have been reduced to: 1) fraud; 2) inadequate capitalization; 3) failure to observe company formalities, and 4) intermingling the business and finances of the company and the member to such an extent that there is no distinction between them.  Gasstop Two, LLC v. Seatwo, LLC, 225 P.3d 1072 (Wyo 2010).  None of these factors, of themselves, necessarily require the court to pierce the corporate veil.  Instead, the court will look to see if “an adherence to the fiction of the separate existence of the corporation would, under the particular circumstances, sanction a fraud or promote injustice.”  Kaycee.  In fact, the Wyoming courts have established a long list of circumstances which might justify holding the owner of a LLC or corporation liable.  These include, among other things, use of a corporation as a mere shell, concealment and misrepresentation of the identity of the responsible ownership, and the intent to avoid performance by use of a corporation as a subterfuge of illegal transactions.

The Wyoming State Legislature, and its Courts, have made clear that although the state welcomes legitimate business (indeed, they try to attract it), there is no tolerance for use of either corporations or LLCs for illegal or improper purposes.  It is a given that in business, anything can happen; profits can be made or lost, and people and businesses may be harmed by unfortunate economic circumstances, or even by poor business  management.  In such cases, the law protects the owners of companies as an inducement to keep contributing to the economic welfare of the state.  However, when someone deliberately uses a business in a way they shouldn’t, or for an improper goal, the owners may be liable for the company’s actions.  However, a smart business owner, with good advice and forethought, should be able to conduct business without the fear that he will be liable for the failure of the business.  The LLC or corporation should be a shield for liability, not a cloak of deception.

Beneficial Owners: It’s Good to be the King

A recent Reuters article reported that Senator Levin (D-MI) has reintroduced in the U.S. Senate his Incorporation Transparency and Law Enforcement Assistance Act.   The article focused on the idea that this would successfully help law enforcement combat the supposed evils of shell companies.

The act, introduced as s.1483, would require all states to collect the names, addresses and unique identifying number (i.e., passport or driver’s license) from every beneficial owner of a corporation or LLC when it is created.  Beneficial owners are defined as persons who 1) exercise substantial control over a company, or 2)
have a substantial interest in or receive substantial economic benefits from the assets of a company.   Interestingly, nominees are excluded from the definition).  A penalty of $10,000 or 3 years in prison, or both, would be imposed on those who knowingly provide false information, fail to update the information when it changes or disclose the existence of a subpoena for the information.

This act is rife with bad assumptions and the potential for unintended consequences.

In U.S. law, a beneficial owner is one who is entitled to the benefits of the property, while another person holds the legal title to it.  The obvious example is a trust, where the trustee holds the legal title to property for the benefit of the beneficiaries.  This act’s definition broadens that.  Now the CEO who instructs a subordinate to create a LLC for a specific purpose becomes a beneficial owner, even if he is never made a member of the LLC.  The manager of the LLC (basically, the CEO) would now be a beneficial owner, because he exercises substantial control.  And the employee with a huge salary, even though not an ‘owner’ in the traditional sense, might be considered a beneficial owner.  While law enforcement certainly needs a way to discover the controllers or owners of a suspect company, requiring states to collect such a broad base of information would bring over-regulation of corporations and LLCs to ridiculous levels.

Nor does this proposed law address the methods that might be used by real criminals.  How does an incorporator or state find out when someone instructs someone else to create and operate a company?  We’re back to the example of the mafia don who tells his girlfriend to set up a company through which he can launder money.  Clearly, he would be the beneficial owner.  But what are the odds that the girlfriend will report that?  Committing a crime by not doing so is probably the least of her sins at that point.  Using a false passport or driver’s license for the beneficial owner falls into the same category.  Setting up the business in violation of the law is probably small potatoes compared to what the business is being used for.

It is like panning for gold.  While looking for the occasional criminal, the net will catch up many small  businesses in over-regulation, destroying privacy and holding small business owners to an impossibly high standard of accountability.  Currently, a lot of business corporation law is a sort of ‘no harm, no foul’ type system.  Many people don’t keep adequate business records, many may unintentionally commingle funds or make other missteps.  These aren’t criminals; they are just small business people who understand their product better than the myriad laws that already govern businesses.  Should we fine them, or throw them in jail, just because their actions are coincidentally similar to the methods criminals use?  This proposed act causes more harm than good, even if its intentions are noble.

It’s Not Just Wyoming

An article by 60 Minutes addresses some of the issues corporations face when deciding to move their operations offshore.  There are some interesting parallels with Wyoming, both in the tax arena and in the methods of creating a corporate business presence.  People seem to forget that the purpose of a business is to make money; it does this by maximizing its revenue and minimizing its expenses.  No one (business or individual) has an obligation to pay the highest tax conceivable, and the laws, both in the U.S. and abroad, permit many ways to create a company without having some huge physical factory floor with a physical mailing address, where hundreds of people are employed.  Huge corporations use these laws to minimize their taxes and other expenses, and small businesses do the same thing.

Reuters is Causing Hysteria Where None is Needed

The latest article by Reuters on shell companies is adding to hysteria about normal business practices.  The author is not reporting news, but is instead trying to justify a pre-determined conclusion established by Senator Levin.  The article contains several inaccuracies and misconceptions that minimal research and education on  the subject could easily dispel.

1.    “Wyoming state legislators will consider three new bills aimed at reining in ‘shell’ companies…”  A shell company is a company with no significant assets or operations.  These bills will do nothing to eliminate such creatures.  The bills raise the fee for non-compliant registered agents, clarify cease and desist orders when companies provide false information, and ban nominee officers and directors.  But none of these laws will stop a company from having no significant assets or operations.

2.   Reuters found that one 1,700 square foot house in Cheyenne is home to more than 2,000 firms, including hundreds of shell companies.  Actually, the original Reuters article carefully specified that more than 2,000 firms were registered at that address.  The address is the location of a commercial registered agent, Wyoming Corporate Services.  WCS also provides virtual business suites, a business tool for creating an office appearance without the commensurate overhead that has been used for decades.  While many companies may give a suite number at that address as their location in Wyoming (required in order to do business in Wyoming), no one other than Reuters has ever suggested that the address is ‘home’ to those companies.

3.   More than 2,000 firms, including hundreds of shell companies.  Yet, Reuters identifies only 3 such  companies, most of which are no longer in existence.  If a shell company is a business with few assets or operations, how did Reuters determine that hundreds are shells?  The only way to do so is to review or audit
each of the companies, one at a time.

4.    Wyoming does not prohibit nominees – individuals who stand in for the real owners of companies to hide their identities.  In fact, nominees serve two purposes: 1) act as an agent for the corporate or individual owner on a board of directors, and 2) preserve the privacy of an owner.  A 2009 United Kingdom case found that nominee directors have the same duty as any other director.  Since the Wyoming law fails to even define a nominee, all it really does is say that a director is a director is a director; something we already know.

5.   Gerald Pitts, the owner of Wyoming Corporate Services, is the principal of 41 firms.  Reuters also reported that neither Pitts nor WCS have ever even been accused of any violation of the law, and are in fact in compliance with all laws and regulations.

6.   Senator Levin’s Incorporation Transparency Act would require states to collect data on beneficial owners.  Federalism, cost and privacy issues aside, how does one identify a beneficial owner?  For hundreds of years, one could incorporate a business without being the owner; attorneys do it all the time.  And how do you collect data where John Doe instructs his girlfriend to create a business and hold ownership of the business, but she still operates the business as he instructs?  This would create governmental regulation every time a business changed hands, or a business wants to bring on new investors.

There are some legitimate law enforcement concerns here.  But Reuters ignores the equally legitimate business concerns.  Reuters does not contribute to a civilized or scholarly discussion of the issues, and does the business community a disservice.

And the Nominee is . . .

Many businesses have nominee officers or directors, often for legitimate purposes.  Recently proposed legislation from the Wyoming Secretary of State would ban all nominee officers and directors from the state of Wyoming.  This is a knee-jerk reaction to the idea that if nominees are being used, something illicit must be going on.

 

The proposed Wyoming legislation fails to define nominees.  A nominee director is a person who acts as a non-executive director on the board of directors of a firm, on behalf of another person or firm, such as a bank,  investor, or lender.  A nominee can also be a resident in a tax haven who lends his or her name to a non-resident for use on the board of directors.  You can see from the definition that there may be many legitimate uses for nominee directors or officers.  Of course, there are also improper uses.

 

Nominees are often used when a controlling person wants to keep his name out of the public record.  There are many legitimate reasons for wanting this.  Among them: a simple desire for privacy, asset protection, not  wanting persons with ill intent to find you (such as police officers owning a home), a need for confidentiality in a small industry, etc.  And then there are the criminals – those who want to control a company, but don’t want law enforcement agencies to know about it, for purposes such as laundering money.  There is an excellent discussion of nominees here.

 

Clearly, there needs to be some well-defined parameters and conditions for the use of nominees.  But to ban them entirely limits commercial activity, particularly in high finance.  A 2009 case in the United Kingdom held that a nominee director still owes a fiduciary duty to the shareholders and the company, and must have some degree of independence in his decisions.  American law doesn’t often directly address the use of nominees, except where they have been used for illicit purposes.  But it makes sense that, regardless of how you become a director or officer, that so long as you hold that position, you must have the normal duties that position entails, and you must be liable for the performance of those duties.

 

As an attorney, I often act as a nominee director on a very limited basis.  When I purchase or organize a  corporation or LLC for a client, I may accept the position of director for a short period.  Normally, all I do is accept the position and then resign on behalf of the client.  My name may appear on the public record (or, since I work with Wyoming Corporate Services, who provides nominees, my name will be on WCS’s records), and the client’s name is only on the private company records.  My actions as a director are extremely limited.  But if I were to sign a contract, or make representations to someone in that capacity, I ought to be held responsible for my actions.

 

Nominee officers and directors have their place in commerce and business.  The idea of employing someone to act as your agent is neither new or nor controversial.  It happens all the time.  If we truly understand the  position and relationship that a nominee holds, it becomes less of a concern.  It should be a simple matter to create some simple safeguards for the use of nominees without eliminating a useful business tool.

Proposed Corporate Transparency Act Causes More Problems Than It Solves

A new article by Reuters, “Shadowy Shell Companies Targeted By US Senate Bill” perpetuates the lie that all shell companies are somehow involved in illicit activity.  The bill itself, S.1483 introduced by Senator Carl Levin of Michigan, is rife with poor assumptions that it will deserve several posts devoted to discussing them.

 

The article refers to shell companies as shadowy.  However, the authors seem to have forgotten that for decades, the U.S. Supreme Court has upheld a right to privacy.  They also ignore the possibility that privacy may be a legitimate concern of a business owner.

 

The article refers back to the original Reuters article,  and reminds readers that they found over 2,000 business registered at a single address in Cheyenne, Wyoming, owned by Wyoming Corporate Services.  However, they neglect to mention that WCS is a licensed commercial registered agent, which is in the business of providing registered agent services for those businesses.  Of course,  there are not 2,000 business all doing business under the same roof.  They simply employ the same registered agent, who also provides mail forwarding and business address services.  Reuters, along with the  promoters of the Corporate Transparency Act, make it seem as  though a business must be a criminal enterprise simply because it wants to do business in a state where it is not located or uses a registered agent which also services hundreds of other companies.

 

This provincial attitude, if fostered, could signal the death of small businesses and interstate commerce.  Do we really want to prohibit businesses from using commercial registered agents?  Do we want to prevent businesses from having office addresses in more than one state unless they have a significant corporate presence and can afford to lease office space?  Are there truly no legitimate reasons for privacy and confidentiality in business?

What Reuters Got Wrong

On June 28, 2011, Reuters published an article entitled “A Little House of Secrets on the Great Plains.”  That article compared Cheyenne, Wyoming and the company Wyoming Corporate Services to ‘the secretive business havens of Cyprus and the Cayman Islands.’

While the article itself raised several interesting and timely issues, the images it evoked were more suited to the fictional work of John Grisham or Tom Clancy.  I freely confess that, like Reuters, before doing some research, my knowledge of finance and business in the Cayman Islands was based largely on ‘The Firm.’  From the comments of President Obama, quoted by Reuters, I’m not the only one to rely on fiction for my facts.  However true this image may have once been, the times have moved on.

Business incorporation in the Cayman Islands works much like that in Wyoming.  Business incorporators in both locales must prove to someone who they are, where they live and how they may be contacted. Since both jurisdictions have such attractive business and tax laws, it is natural for businesses geared toward helping companies incorporate, register and operate, to flourish. As discussed in earlier posts, commercial registered agents may represent thousands of businesses; business service providers offer executive business suites (both virtual and actual), mail forwarding, telephone services, etc.  None of this is unique to either  Cayman or Wyoming, but since these places have favorable laws, it makes sense for businesses to gravitate there.

But business environments aside, there are some significant differences.  There are 280 or more banks in the Cayman Islands;  Wyoming is home to all of 37 banks.  Cayman has historically had no taxes at all.  Wyoming, while lacking corporate income tax, does have a minimal sales tax, and generates a great deal of revenue from oil and gas production.  While Wyoming makes a great effort to attract business to the State, its banks hold maybe $6.8 billion in assets, while Caymanian banks holds about $1.8 trillion in international assets.

By relying on the fictional stereotype of Cayman being a breeding ground for international money launderers and other crooks,  Reuters has done Cayman, Wyoming and itself a great disservice.  While you can find villains in any population, Cayman and Wyoming have both taken great thought and care in creating a business and banking atmosphere designed to attract legitimate business and revenue to their respective jurisdictions.  But even with all that business, the odds of seeing Tom Cruise acting as a tax lawyer relaxing on the beach after advising his clients about tax evasion seem pretty remote for Cheyenne, Wyoming.

Aged Corporations, Like Fine Wine, Should be Savored in Moderation

Aged corporations have their place in the business world.  An aged corporation, or shelf company, is a company that has no  activity.  The company may be a corporation or a LLC.  A shelf company may also be a shell company, but they are not the same thing.

There are many reasons a shelf company may have no activity.  When I started my business, I had no activity; fortunately, that has changed, over time.  But remember the business model of the incorporator.  His product is a corporation or LLC.  He builds an inventory of product by incorporating (or organizing) many companies, so that he can sell them quickly and easily.  If a company does not sell right away, it begins to ‘age.’  This is nothing sinister, so far.  In fact, incorporators have discovered that many people will pay more for a company that is older.  Still, there is nothing sinister – just supply and demand.

There are many legitimate reasons for buying an aged company: 1) it saves the time and effort involved in starting up a company; 2) it creates the appearance of corporate history; 3) it may aid in obtaining corporate credit; 4) it may help in getting investment
capital, 5) it seems neat.  Really.  That last one is a reason many people may buy an aged corporation.  In the asset protection arena, which is often fueled by seminars and books, buying a company can be a fad.  It seems like a good idea, but once the purchase is made, the buyer loses interest or doesn’t know what to do with it.  But more sophisticated buyers often have a specific purpose in mind for a shelf company.  Sometimes, an aged company makes the owner(s) feel good, because they have a company with a history.  And there is nothing immoral or illegal about trying to obtain corporate credit, boost investor strength or capital, or speed up the start-up.

But ‘shelf corporations’ make us feel uneasy because it seems deceptive to buy a 10 year old company and tout its history to the world without actually putting in 10 years’ worth of work.  After all, if I buy an aged corporation and advertise as “Joe’s Bait Shop – Offering Bait Since 1492” I’m really just deceiving the public in order to boost sales.  But is that different from the puffery a car salesman spouts, in anything other than degree?  And if you perform some reasonable due diligence when dealing with a company that claims to be older than it really is, what kind of harm is inflicted?

So shelf companies, or aged corporations, have their place in the business world.  But they are not for everyone.  The purpose they serve may range from an internal good feeling to aiding with corporate credit.  They are not for everyone, and they can be used for deceptive purposes.  Sometimes, there are innocent reasons why a company may age (I start the company, lose interest or opportunity for years, then get back to work).  In moderation, shelf companies serve the economy well.