Return to Virginia Business - April 2004

Albert Hartley is almost giddy as he talks about the benefits of Virginia's six-month-old business trust law, a package of rule changes that give businesses sweeping new freedom in how they organize and operate. “Very rarely does a statute come along that allows you to do things easier,” says the Chesapeake-based attorney, who has drawn up half of the trusts created here since they became legal last October.

The new law offers the membership flexibility of a limited liability company, the liability protection of a corporation and lets beneficial owners set up their own rules of governance. It also lets investors use the same legal entity for multiple investments or business operations without exposing the assets of one operation to the creditors of another.

Business trusts aren't new; 20 states allow them. But backers of the law say its adoption here boosts claims that Virginia is as friendly a place for businesses as Delaware, the nation's top location for corporations. “If you simply threw this into a computer and took out all of your biases and you took out the external forces you are always facing, you'd always choose Virginia,” says McGuireWoods attorney Les Grandis.

But Virginia isn't even close to catching Delaware, where more than half a million business entities have their legal home, including more than 50 percent of all U.S. publicly traded companies and 58 percent of the Fortune 500. Its reputation for having favorable tax rules and pro-business liability laws is virtually unchallenged.

That makes it tough for Virginia and the other 48 states. The institutional bias among bankers, lawyers and Wall Street analysts favors Delaware, where they feel comfortable after a half-century of experience. “There's a herd mentality that's tough to overcome,” says Randall Parks, the attorney with Hunton & Williams in Richmond who helped draft the legislation.

Some lawyers and proponents think the new business-trust law, though, could help make Virginia more competitive. The law's flexibility gives business owners a lot of leeway. One trust that Hartley established for a client purchasing distressed notes says the client will receive 50 percent of profits, but no share of any losses. The freedom to write their own rules allows trust owners such flexibility and the ability to assign profits and loses or responsibilities any way they want.

“I absolutely love the idea,” says David Jablonski, who has used trusts for 10 years but recently converted to Virginia's new statute to protect the assets of his Alexandria security business. Should something happen to him, he says, the trust would help his wife and brother avoid selling off the business to pay taxes.

One of the biggest advantages of Virginia's new statute is the elimination of the costly and time-consuming process of creating new REITs or corporations for different investments. An owner can use a single trust to own multiple properties and businesses ventures. He can create a different “series” that establishes what amounts to be a separate business on paper to handle different business deals. The same trust can even include a venture with different partners than other series in the trust. So if one series fails, partners in another are unaffected. New partners can be added with ease by simply declaring a new series. And a series can also be dissolved without killing the entire trust.

The impetus for the legislation grew out of Parks' frustration of forming REITs and business trusts in Maryland. Backed by the Virginia Bar Association, Parks and other lawyers studied existing trust laws in Delaware, Maryland and Massachusetts and rolled them into what they believe is a better mousetrap. “We thought that we needed this for the REIT practice so we can begin to form these here,” says Parks, whose firm has one of largest practices for REIT public offerings and underwritings.

The new law and a renewed popularity of REITs as investors pour more money into real estate could make the business trusts a popular vehicle. Already most of the trusts formed have been for real estate deals. Parks hints that Virginia could have its first publicly traded REIT by year's end, but he won't divulge details.

Yet for all these advantages, only 25 trusts were formed through February. One reason is that the trusts are only really useful for a few applications, such as real estate investment trusts, securitization deals and mutual funds, all of which are more commonly based in Maryland, Delaware and Massachusetts, respectively. “It's not the world's most important entity,” says James J. Wheaton, a securities expert at the Troutman Sanders law firm in Virginia Beach.

Advocates of the law are not surprised it hasn't taken off yet. Senate Majority Leader Walter A. Stosch, who sponsored the legislation, says it's just another tool designed to encourage businesses to locate in Virginia. Parks likes to describe the little known statute this way: “Pick the weirdest tool in your toolbox, that's what it is. You may not use it everyday, or maybe only once a year, but you'll be glad you have it.”

The fact that it's new appeals to Hartley, whose entities include the Behemoth Business Trust — named because he and a partner are overweight — and the Elah Trust — named for the valley where David slew Goliath. Old-school attorneys don't know or understand the legislation, says the 30-year-old, who describes it as more of a virtual vehicle appropriate for the New Economy.

Wheaton and others, though, say Virginia would be better off marketing the advantages of existing state corporate and tax laws that arguably make it a more attractive location for doing business than popular Delaware, which last year did a nationwide mailing touting itself as the destination of choice for corporate registrations.

From taxes and registration fees to the courts, Virginia is probably a better place to incorporate, says Wheaton. “You have business statutes that are very up to date and cutting edge and provide all the advantages that people think they get when they go to Delaware. We have every innovation that Delaware has in there; we've got some that they don't.” Corporate fees in Virginia, for example, can be lower than in Delaware. (see chart p. 22)

Virginia law also provides corporate directors better protection. Under what's known as the business judgment rule, directors only need to show they acted in good faith; they don't need to prove they acted in the best interests of shareholders even if they vote against the recommendations of counsel. “It's an anti second-guessing statute,” says Wheaton, of the law that has been a key weapon to help companies such as WLR Foods of Winchester and Dana Corp. fend off hostile takeovers.

In the end, money and the ease of incorporating are usually the chief reasons businesses set up shop in Delaware. For an extra $1,000, the incorporation process can be completed online in as little as one hour. A simple Google search for “Delaware incorporation” yields an enormous cottage industry that has sprung up that makes the process simple even for the smallest of businesses.

While proponents of doing business in Virginia tout that the state's 6 percent corporate income tax is lower than Delaware's 8.7 percent rate, relatively few companies end up owing much. That's because Delaware's tax applies only to companies that have a physical presence there.

And many of the biggest corporations in Virginia pay little or no taxes by shifting income into Delaware holding companies that exist only on paper. A 1999 report by Virginia's Department of Taxation found 21 of the 50 largest companies operating in the state avoided paying income taxes by using such strategies.

So, it's no wonder that Gov. Mark R. Warner and some in the General Assembly want to close some loopholes. Corporate tax shelters cost Virginia $151 million in 2001, according to one study. “I'm interested in making sure Virginia gets its share,” says Sen. John C. Watkins, (R-Powhatan County), who sponsored one loophole-targeting bill. “We need corporations because that's where the jobs are, and we need to keep as many of the large corporations located in Virginia as we can. But there's a responsibility that comes along with that… Be fair and equitable.”

But closing those loopholes could also hurt. Smithfield International Investments, which has a Delaware holding company, told The Virginian-Pilot that closing the loopholes could cost it as much as $1.8 million a year. “We're a Virginia company, and we'd never pick up and leave. But it certainly would cause us to rethink where we'd put future plants and money,” said Smithfield Executive Vice President Richard J.M. Poulson.

In the end, the numbers, court cases and regulations may be pointless until Wall Street bankers, analysts and lawyers are willing to look beyond what they're comfortable with.

Return to Virginia Business - April 2004