Doug Cornelius .com

William V. Hovey published his regular column in Massachusetts Lawyer’s Weekly: Choosing the Best Real Estate Holding Entity.

He discussed the entities in this order:

• Individual
• Tenants in Common
• Joint Tenants
• Tenants by the Entirety
• Trust – Standard with named beneficiaries
• Nominee Trust
• Massachusetts Business Trust
• Corporation (C corp)
• Corporation (S corp)
• General partnership
• Limited partnership
• Joint venture
• Limited liability partnership
• Limited liability company

This is a good outline of the issues. But I think Mr. Hovey is little off base on a few points.

First, a joint venture is not an holding entity and has no place in the list. Several of the other types are not entities, but they at least ownership choices.

Second, he states that limited partnerships are “likely to be replaced by LLCs and LLPs.” I hate to break it to Mr. Hovey, but LLCs replaced limited partnerships about a decade ago. I rarely see LLPs used for real estate ownership in Massachusetts.

Disclaimers

Charities should not use a limited liability company to hold real estate in Massachusetts. Robert E. Cowden wrote an article about this in the November/December 2007 issue of the Boston Bar Journal.

The Massachusetts Appellate Tax Board ruled that even though a piece of property was owned by a single member limited liability company, whose sole member was a charitable corporation, the property did not qualify for property tax exemption. CFM Buckley/North, LLC v. Board of Assessors of the Town of Greenfield.

The Third Clause of M.G.L. c.59, s.5 provides for a property tax exemption for a charitable organization, which is defined as:

(1) a literary, benevolent, charitable or scientific institution or temperance society incorporated in the commonwealth, and (2) a trust for literary, benevolent, charitable, scientific or temperance purposes if it is established by a declaration of trust executed in the commonwealth . . . . [emphasis added]

The Appellate Tax Board found that a limited liability company is not “incorporated” and therefore does not qualify for the exemption.

On a similar note, other protections for charitable organizations may be jeopardized if they use a limited liability company to hold some of their real estate assets.

For instance, the Dover Amendment M.G.L. c.40A, s.3 provides that:

No zoning ordinance or by-law shall regulate or restrict the interior area of a single family residential building nor shall any such ordinance or by-law prohibit, regulate or restrict the use of land or structures for religious purposes or for educational purposes on land owned or leased by the commonwealth or any of its agencies, subdivisions or bodies politic or by a religious sect or denomination, or by a nonprofit educational corporation. . . .

Also the charitable liability cap in M.G.L. c.231, s.85K is applicable to:

corporation, trustees of a trust, or members of an association that said corporation, trust, or association. . . .

A limited liability company may not be able to take advantage of these protections.

When a corporation sells real estate in Massachusetts there is the always the concern of whether there will be a three year, inchoate lien on the real estate. Under Massachusetts General Law Chapter 62C, Section 51:

At least five days prior to the sale or transfer. . . of all or substantially all of the assets situated in the commonwealth of a domestic or foreign business corporation, except in cases where a waiver shall be given as hereinafter provided, the corporation or any person in interest shall notify the commissioner in writing of the proposed sale or transfer, and of the price, terms and conditions thereof, and of the character and location of the assets and cause to be filed with the commissioner all such tax returns as may be necessary to determine the taxes due and to become due and payable to the commonwealth to and including the date of such sale or transfer, and shall pay to the commonwealth all such taxes owing to said date of sale or transfer. . . In the event of a failure to notify the commissioner and so to file such return or returns and pay such taxes at or before the time of such sale or transfer, the commonwealth shall have for its exclusive benefit a lien upon all of the assets of the corporation in the commonwealth effective immediately prior to such sale or transfer to the extent necessary to satisfy said taxes. Said lien shall terminate not later than three years after the date of said sale or transfer and until such termination may be enforced under and in accordance . . . .

If the real estate is not substantially all of the assets of the corporation in Massachusetts, you can just put a statement in the deed: “This deed is not a sale of all or substantially all of the assets of the corporation in the Commonwealth of Massachusetts.”

But if that is not true and the sale of the real estate is all or substantially all of the assets of the corporation in Massachusetts, you need to get a waiver of the tax lien.

You can apply for a Certificate of Good Standing or Tax Compliance from the Massachusetts Department of Revenue. But the process can take weeks, if not months, for the DOR to issue the certificate.

It is quick and easy to set up a single member limited liability company to take title to the property. The corporation can be that single member.

Last week I noted the story and decision of City of Springfield Code Enforcement v. Concerned Citizens for Springfield, Inc., et al. in which Housing Court Judge William H. Abrashkin ordered the individual manager (Shalom Segelman) of the property owning limited liability company to pay $1.3 million in relocation costs for the tenants in the sub-standard apartment complex.

After reviewing the case, it is not clear whether the judge was piercing the liability shield of the LLC or carving an exception to the liability shield.

M.G.L. C. 156C s. 22 provides that no “. . . member or manager of a limited liability company shall be personally liable, directly or indirectly, including, without limitation, by way of indemnification, contribution, assessment or otherwise, for any such debt, obligation or liability of the limited liability company solely by reason of being a member or acting as a manager of the limited liability company.” This is the liability shield for a limited liability company.

Judge Abrashkin looks to the definition of owner under the State Sanitary Code (105 CMR 400) that imposes obligations on the owner. The code has a very broad definition of owner:

“Owner means every person who alone or severally with others:

(1) has legal title to any dwelling, dwelling unit, mobile dwelling unit, or parcel of land,vacant or otherwise, including a mobile home park; or
(2) has care, charge or control of any dwelling, dwelling unit, mobile dwelling unit or parcel of land, vacant or otherwise, including a mobile home park, in any capacity including but not limited to agent, executor, executrix, administrator, administratrix, trustee or guardian of the estate of the holder of legal title; or
(3) is a mortgagee in possession of any such property; or
(4) is an agent, trustee or other person appointed by the courts and vested with possession or control of any such property; or
(5) is an officer or trustee of the association of unit owners of a condominium.

Each such person is bound to comply with the provisions of these minimum standards as if he were the owner. Owner also means every person who operates a rooming house.”

My reading of Judge Abrashkin’s decision is that this definition of owner is an exception to the liability shield of M.G.L. C. 156C s. 22.

I disagree with a statement in the Judge’s analysis: “Had this complex gone in the other direction Mr. Segelman would, rightly, have insisted upon reaping the rewards. With the benefits go the burden, and this one falls unavoidably, upon Mr. Segelman.”

One the basic paradigm’s of investing in real estate (and any business) is being able to limit your losses. If I went out and bought a share of Boston Properties, Inc. (BXP) I would pay the $104.37 that it costs (as of this morning). I have unlimited upside. The stock could triple in value and pay out enormous dividends. My downside is limited to the $104.37 that I paid for the share. As a shareholder, I would never expect to get a bill to contribute more capital to Boston Properties because one of their buildings is in disrepair.

I expect the same treatment if I were an individual investor in a limited liability company that directly owned an apartment building. I know my initial capital is at risk, but I should not have to put additional capital in (unless I agreed to under the limited liability company agreement). I could lose all of my investment. But I should not have to lose more than my investment.

That being said, there are some exceptions to this liability shield. In real estate, there is CERCLA’s ability to look through entity for liability due to environmental contamination. (You can read this article by Daniel M. Darragh of Buchanan Ingersoll & Rooney PC on Indirect Owner/Operator Liability Under CERCLA). There is also the equitable remedy of piercing the corporate veil.

In his order, Judge Abrashkin did not discuss any of the factors for piercing the corporate veil. So I am left to assume that the Massachusetts state sanitary code is an exception to the limited liability of an entity.

In the case of Orix Financial Services, Inc. v. Leclair (S.D.N.Y. Feb 26, 2007) the court found that under Rhode Island law, an individual who assumes to be acting for a corporation without authority to do so is liable for all debts arising from the action.

Mr. Leclair defaulted under his obligation under a note. The maker of the note was “Brian Leclair DBA T and D Excavating Co.” Unfortunately for Mr. Leclair, the charter for T and D had beeen revoked two year prior to the execution of the note.

Under R.I. Gen. laws Section 7-1.2-1801: “All individuals who assume to act as a corporation without authority so to do are jointly and severally liable for all debts and liabilities incurred or arising as a result of that action.”