Our clients often ask us about the benefits of transferring their rental properties into a Limited Liability Company (L.L.C.). While LLCs and other corporate entities offer some degree of protection from the personal liability, there are a myriad of factors that must be considered in making the decision to transfer your properties into one of those entities.
Due on Sale Clause
We will start our discussion with a familiar concept that owners often overlook when deciding to transfer their properties to an LLC. In cases where the property is encumbered by a mortgage or loan, it is extremely likely that the loan document contains a “Due on Sale” clause. This provision, contained in nearly all loan agreements, sets forth that, upon the sale of the property, the lender may require the borrower to pay the full balance of the loan. While this clause is clearly intended to protect the lender in the vast majority of sales, where the property is sold to a completely unrelated party, it can also be invoked in cases where the owner is merely trying to deed the property to corporate entity in which the owner remains a member or shareholder. Accordingly, in all cases where the owner intends to deed a mortgaged property to an L.L.C., the owner should first consult with the lender to get a decision in writing whether the deed transfer would trigger the due on sale clause.
What if the property is not mortgaged?
In some cases, the property to be deeded to an L.L.C. is not encumbered by a mortgage, and therefore, there is certainly no reason in these cases to worry about a due on sale clause. However, properties that are owned outright and without mortgage pose some practical considerations as to how much protection the L.L.C. really affords the owner of the property. While the recourse of a litigant or creditor against the L.L.C. is normally limited to the assets of the L.L.C., the chances are that the assets of the L.L.C. for a property that is owned “free and clear” are quite substantial. It would, therefore, be misguided for an owner to be content in just knowing that a potential creditor could only seize the L.L.C. protected real estate (and not the personal assets of the owner). Put simply, the L.L.C. really only protects the owner to the extent that a possible claim may exceed the value of the real estate that has been deeded to the L.L.C. In our experience representing property owners, the chances of a claim being awarded in excess of the value of the real estate are extremely small.
Use a Separate L.L.C. for each Property
Notwithstanding the above, the use of an L.L.C. does provide an additional layer of protection against liability. However, in light of the fact that the L.L.C. cannot protect the property that is deeded into the L.L.C., the property owner should never attempt to include multiple properties in a single L.L.C. Rather, a separate L.L.C. should be used for each property in order to reduce the likelihood that a claim would be enforced against multiple properties.
Other practical considerations of the L.L.C.
Finally, we note that even in cases where the property has been transferred to an L.L.C., there are cases where Courts may allow the claimant to pierce the corporate entity and still pursue a claim against the individual member. These unfortunate outcomes are most likely to occur in cases where the individual does not take adequate steps to differentiate himself or herself from the L.L.C. In order to minimize the chances that such a decision would be granted in favor of the claimant, members of the L.L.C. should make sure they always conduct business as the L.L.C. when acting on behalf of the L.L.C. For instance, the name of the L.L.C. should be used on all print material (including leases, code enforcement certificates and notices) relating to the property. The L.L.C. should also use its own bank account and have its own Tax Identification number.
For more information relating to L.L.C.s and other corporate entities, please feel free to contact our office.