Why In the World Would Anyone With More Than One Shareholder Form a Corporation in Nevada?

That’s the question you may ask yourself after examining Nevada Statute 78.347, which allows any shareholder, regardless of their percentage of stock ownership, to petition the court for the appointment of a custodian of the corporation when the business of the corporation is suffering or is threatened with irreparable injury because the directors are so divided respecting the management of the affairs of the corporation that a required vote for action by the board of directors cannot be obtained and the stockholders are unable to terminate this division.

If the petition is granted, the custodian is allowed to continue the business of the corporation and not to liquidate or distribute its assets, except when directed by the court.

This provision is often overlooked by businesses that have been attracted by Nevada’s aggressive marketing efforts touting it as the new corporate haven. Online ads offer low-cost incorporation services urging businesses to take advantage of Nevada’s corporate-friendly laws. But if you plan on having more than one shareholder, the statute above should make you think twice before you incorporate in Nevada.

Not only does NRS 78.347 allow any stockholder unfettered access to judicial intervention, but it makes public any internal dissension and conflict that would otherwise be kept within the corporation. It removes the resolution powers from the directors and places unilateral authority in the hands of the court-appointed custodian.

The stockholder applicant is required to submit a sworn affidavit providing, among other things:

• Evidence of reasonable efforts by the applicant to contact the officers and directors of the corporation; and
• Evidence of a demand by the applicant to the officers and directors that the corporation comply with the general provisions governing private corporations in Nevada and that the applicant did not receive a response.

Once appointed, the custodian must provide the courts with periodic reports of the activities of the custodian, directors and the progress of the corporation. The custodian also has 10 days after appointment to contact the officers or directors and request that the corporation comply with corporate formalities and continue its business.

This statute is yet to be challenged in a Nevada higher court. One of the few reported cases dealt indirectly with the issue where a Kansas court rejected the claim of a creditor against a court-appointed custodian in Valley View State Bank v. Owen, 737 P.2d 35 (Kan. 1987).

This lack of precedent allows courts broad discretion in granting custodianship to any shareholder, minority or otherwise. Moreover, the statute does not place a time limit on the custodian’s authority to conduct the corporation’s business and further the interests of the shareholders.

Critics say that statutes like NRS 78.347 allow stockholders to make a procedural nuisance of themselves. This nuisance factor alone can consume tremendous amounts of management and board time and become costly to the corporation.

In its efforts to become a corporate-friendly state, Nevada has failed to strike a balance between the rights of stockholders and the directors’ flexibility and autonomy in managing the corporation’s affairs.