Protecting Real Estate Assets

by Thomas V. Bennett

The ownership or investment in real estate provides a number of choices with respect to how to hold title particularly if there are partners who own the real estate.
 

Real estate can be owned in the individual's name, or, if a couple, it can be owned as: tenants by the entirety for married persons either of the same or different gender; joint tenants which means that upon the death of either, the property will pass to the other by operation of law; as tenants in common under which on death the property would pass to the heirs or devisees of the deceased owner; or as tenants in partnership in which the deceased partner's interest would pass to the other partner by operation of law with the duty and obligation of the remaining partners to account to the heirs of the deceased partner as of the date of death as to the value of the deceased partner's interest in the real estate.
 

Ownership of real estate poses liability problems for negligence of the property owner which could result in personal injury to either the tenants or parties visiting the property. Real estate can also be attached for the debt of the owner. For those reasons, i.e. to limit liability and to make the interest in the real estate difficult to be attached, people very often own real estate in different entities.
 

For many years, trusts were a popular entity for holding title to real estate, particularly so-called “nominee trusts” which are really straw transactions where the trustee holds title for the benefit of the owners pursuant to a schedule of beneficiaries that is not recorded at the Registry of Deeds. The problem with that form of ownership is that during the dark real estate days of the 90's the FDIC was very aggressive in suing the trustees and the beneficiaries of nominee trusts on the basis of theories of law which hold that both the trustee and the beneficiaries as the agent and the principal can be held personally liable for the obligations of a note secured by a mortgage on real estate . Corporations were never really popular in the ownership of real estate because although they provide limited liability, they had adverse consequences in that a corporate tax would have to be paid, in addition to the individual tax.
 

Limited partnerships were used frequently where there were in fact investors and a general partner who would really run the real estate entity. Those, however, were cumbersome and expensive for the smaller commercial property owner and in order to again avoid liability, the general partner was generally a corporation which had to be more than a shell in order to pass muster under the tax code all of which added additional levels of cost for excise taxes, accounting and legal fees.
 

The limited liability company and the limited liability partnership have provided an ideal solution for protecting both against liability and allowing for partnership treatment for tax purposes similar to the use of the nominee trust and the limited partnership. There is an expense, however, since the annual filing fee for a limited liability company or a limited liability partnership is $500 per year.
 

No matter what form of entity is selected, there are still issues to deal with on what happens if one party wishes to sell their interest or becomes bankrupt or dies. The other concern is a creditor who seeks to “reach and apply” the interest of a party in such entity. The courts have held that a creditor may “reach and apply” a debtor's interest in intangible property that cannot otherwise be executed against in an action of law; i.e. a beneficial interest in a trust or a membership interest in a limited liability company or a limited liability partnership.
 

Although creditors may not “reach and apply” a debtor's interest in a trust that includes a “spendthrift” clause by which the creator of a trust forbids creditor attachments, special rules apply when the party creating the trust creates a trust for his or her own benefit and also attempts to immunize the trust from creditors' claims. In Massachusetts the courts have adopted a rule that provides that a creditor may reach the maximum amount that a trustee of a trust could pay to a beneficiary. This rule keeps the debtor from protecting “his property in such a way so he can still enjoy it but prevent his creditors from reaching it.” It is not necessary for the party to intend to defraud his creditors. The rule has special force in the case of nominee trusts where the beneficiary can control the trustee's actions but it applies even where the trustee has sole discretion. Even if there are anti-assignment clauses in the trust agreement or the operating agreement of the limited liability company, the court has ruled the reach and apply statute in Massachusetts is broadly written and contains no express reservation for cases in which an anti-assignment clause exists. The courts have found that a court can override a self-imposed non-assignment clause as readily as self-imposed clauses barring creditor attachment. The court can in applying the reach and apply statute impose equitable limitations if the court, due to operational provisions for example, felt that they would be important.
 

It is important, therefore, in any entity in which more than one individual is going to be involved that the entity take into account through its operating agreement or a joint venture agreement, if a trust, or any other operating document for its governance, the transfer of membership interest either voluntarily or involuntarily and how that will impact the operation of the entity and should also provide for possibilities of expulsion and the calculation of what the payment should be for the expulsion for the interest of the party being expelled and how it will be paid; for example, by note over a period of time at a favorable interest rate.
 

This is particularly of concern for so-called “high risk” professionals such as doctors, lawyers, chiropractors and others, as well people actively involved in businesses where they sign guarantees and otherwise incur personal liability.
 

Those folks who own real estate in a trust should consider, given recent court rulings involving trusts, a different form of entity to hold title to investment real estate and the provisions of the governance agreement among the members of that entity.