The Ultimate Planning Guide: Asset Protection for Commercial Real Estate

Disclaimer: This guide provides educational and general principles about asset protection for commercial real estate.  It in no way represents a proposal, legal advice, or specific recommendations as to any party which may obtain it. CXRE LLC does not offer tax or legal advice. See below extended disclaimer.

What is Asset Protection Planning? What Does it Mean for Commercial Real Estate Investors?

Asset protection for commercial real estate investors includes three categories:

  1. Lawsuit protection,
  2. Tax reduction, and
  3. Estate planning.

There are strategies you can use to protect your professional and personal assets against lawsuits. There are strategies you can use to reduce your taxes. And there are strategies you can use to effectively pass your estate to the heirs you select. Before choosing a plan for asset protection for commercial real estate, you must first understand the strategies and tools used in all three categories. Additionally, you should understand how they interrelate to set up an effective total asset protection plan. This guide gives a generalized overview of strategies and tools that can help protect your assets against lawsuits.

If you have available and reachable assets, it is not a matter of if you will be sued, but when. These asset protection strategies can help you mitigate the financial damage you incur.

Premise Liability for Commercial Real Estate Investors

Personal injury litigation is a booming business, bringing in $38 billion every year. Each year, complainants file personal injury lawsuits against business owners and property owners. Common complaints include slip and fall injuries, which are a leading cause of personal injury cases nationwide.

Property owners make an attractive target because the owner is easy to locate and generally will have insurance. For this reason, it is extremely important to prepare your commercial property to face potential liability. Lawsuits can come from unknown third parties in addition to the owner’s personal creditors, business partners’ liabilities, and perhaps even (former) family members. Generally, a multi-pronged approach would be deemed as the most prudent course of action, which includes:

  1. Planning the proper ownership structure for your commercial real estate assets (including anonymity and isolation techniques),
  2. Obtaining proper insurance coverage (including ensuring that the standard of care with respect to the management property is commensurate with the type of property), and
  3. The use of knowledgeable and creative legal counsel who will be able to properly shield the individual owner from being identified. This attorney will act as an intermediary in business matters, potentially settling or preventing a litigation event from happening and adding to the owner’s potential exposure.

Other important topics are addressed below as well.

Financial Privacy for Texas Commercial Real Estate Investors

Aggregator services allow personal injury attorneys, family attorneys, and creditors to obtain detailed financial information reports on just about anyone targeted by a lawsuit. These reports describe in detail all of the target’s bank accounts, assets, real and personal property, marital information, and a great deal of other significant information. We all know there is little to no real privacy these days. In addition to these reports, highly intrusive forensic accounting specialists may also comb through all electronic records of a defendant.

Information from Amazon, Facebook, Google and other accounts is widely available to governments and other private parties. These third parties then purchase and resell that information. The goal of asset protection is to isolate personal assets from business assets. Then, business assets are segregated and isolated into as many separately protected units as necessary. This process reduces the risk of one business asset adversely affecting another business asset in the event legal risk materializes.

Entity Structure Planning for Holding a Texas Commercial Real Estate LLC

An LLC is always the best way of holding real property. The reasons are numerous and well settled, and this guide is too brief to go in-depth on this point. Depending on the value of the real estate in question, the general plan should be to have one or two properties in a single LLC. Most advice warns against more than three properties in a commercial real estate LLC, unless they are very low-risk assets with substantial insurance coverage (Class A properties). In most instances, the best course of action is a single commercial property per LLC. For instance, a commercial real estate LLC for asset protection.

Pro Tip: Since Texas is rather nosy with regard to entity ownership, each LLC-owned property should further be owned by an out-of-state LLC holding company permitting anonymous ownership, such as Delaware or Wyoming. 

The Series LLC

In Texas, a newer strategy for a commercial real estate LLC is called the “series LLC”. This type of entity is like having multiple LLCs in one, each being called a series (series A, B, C, etc.) Each series represents a separate entity to maintain its liability protections. As such, each may have different ownership, distribution interests, voting rights, management, and any other governance agreed to by the owners. The Series LLC is too new and untested in litigation to recommend its use with commercial, high-value assets. It’s still unknown to what extent the LLC must segregate assets and liabilities to maintain asset protection for commercial real estate.

Is It Worth the Risk?

It is too risky to own a property in each series. Currently, the Series LLC risks judicial interference for yet unknown reasons. On the other hand, regular LLCs have extensive case law and offer far more predictable treatment by courts. Each series needs its own bank account, operating agreement, and must operate as a separate company. Therefore, the prudent course of action is to spend a few hundred dollars extra and form totally separate entities to ensure peace of mind. However, a Series LLC might be an appropriate option in low-risk situations, such as holding numerous individual business property assets or entering into agreements.

Texas is rather nosy with regard to entity ownership. Therefore, each property should further be owned by an out-of-state LLC holding company permitting anonymous ownership, such as Delaware or Wyoming. New Mexico is also an option, but their LLC laws are not as well developed as the others. Furthermore, note that no asset protection or anonymity plan is impenetrable. There are always ways of getting the name(s) of the owner(s) if one digs hard and long enough. The goal here is to create as many barriers and to increase the cost to potential litigators. This will hopefully dissuade the potential plaintiff from continuing with its efforts. Ideally, the holding company should have no bank accounts, EIN, or enter into any contracts. This would force disclosure of principals and would likely wind up on some private discoverable database.

Pro Tip: A technique that has worked well in Texas is to use a trust to own an LLC as its ‘member.’ The LLC is listed as the beneficiary of the trust

Using a Trust to Own an LLC as it Member

One commonly used technique in Texas is using a trust to own an LLC as its ‘member.’ The LLC is listed as the beneficiary of the trust. This works well in situations where a company isn’t required to reveal its private trust document to third parties. For example, in financing situations, the lender would definitely request all trust documents before granting a loan. (The same as all governing documents of a parent LLC). A personal guarantee would still be required from the trustee or settlor (creator of the trust).

In this instance, when selling a property, the LLC would need to reveal the relevant documents. An LLC makes the buyer’s due diligence process easier in this instance. Lenders and buyers are familiar with holding companies, but not as familiar with ownership trusts. Therefore, this may make obtaining a loan more difficult. In the event of creditor action against the trust-owned LLC, the trust agreement should stipulate that the trustee has the right to appoint a successor trustee to maintain anonymity. This successor trustee may then transfer the LLC assets to another LLC (risky, therefore in limited situations), to terminate the trust, or to remove the trust to another jurisdiction.

It should be noted that regardless of whether or not a trust owns the LLC, affected parties should still consider and utilize all the other types of LLCs listed below. These options include management companies entering into agreements and collect rent, IP holder LLC, and business property owner LLC.

Public Information Report

The required annual Public Information Report works equally well with trusts or parent LLCs. The drawback to using a trust is that it provides no legal protection except for the LLC itself. As such, a suit will generally name the trustee as the defendant for actions of the trust. A suit will also name the trustee as the defendant in a claim against the LLC because the LLC is the property of the trust.

A plaintiff will generally fire off as many causes of action as possible. This strategy induces panic and increases the chances of a favorable judgment. This scenario is not possible with an LLC parent since there is no contractual privity with the parent: only the subsidiary may be sued directly. Furthermore, it’s easier to obtain third party signatories for agreements by use of the parent/subsidiary LLC structure. This is because the trustee, who is attempting to maintain anonymity and is also the principal, would generally need to sign all legal documents, short of a power of attorney or engaging a third party specifically for this purpose.

A plaintiff will serve the service of process to the registered agent of the Texas commercial real estate LLC. This would go to the trustee, who would then have to answer the suit or risk default judgment against the entity and trustee personally. With a parent holding company, the process goes to the parent company. Then, the parent company has very few response options, if any at all.

Pro Tip: Occasionally, some situations require an additional layer of protection. In some cases, investors utilize an offshore entity (like another LLC), which will own 100% of the holding company. 

A Triple Entity Structure

Occasionally, some situations require an additional layer of protection. In some cases, investors utilize an offshore entity (like another LLC), which will own 100% of the holding company.

Such a triple entity structure is nearly impenetrable with respect to liability. The offshore entity becomes the main holding company. This entity may also own other offshore entities which hold assets, but should not directly hold assets itself. The operating agreement of this entity would stipulate that, should legal action be implemented against it, the manager member may terminate the company and remove its assets (U.S. holding company) to another jurisdiction. There would be no way to invalidate this action.

Additional Holding Entities Often Necessary

The above only covers entities that actually hold real property. You should also form additional companies to carry out business activities. This company acts as the management company or the public face of the investor. As such, this “public face” enters into all agreements with service providers, vendors, staff, collects rent, deals with lawsuits, and the like. This activity should not be carried out through the holding company but should be a totally separate, stand-alone LLC. In addition, this LLC will have a management agreement executed between the parent holding LLC and this management entity.

LLC for Business Property

An additional separate LLC should own the business property (furniture, equipment etc.) and lease it back to the management LLC for use by each property holding LLC. This way, any injury by equipment or other personal property, such as a vehicle, would only endanger the company that owns it, not the company that owns the building. Note here that under the principles of respondeat superior and vicarious liability, the complainant will also likely sue the management LLC for acts of employees during the course of employment. Therefore, the management company should also have adequate insurance coverage.

Intellectual property is also a valuable asset and should not be mingled with any other company. Place copyrights, trademarks, and patents in their own separate LLC (or even multiple LLCs, depending on their value) and license them to the management company for use by each property-owning entity. 

Building Insurance Coverage Plus

The above is a basic description of asset protection planning. It represents an important – but not perfect – method to attempt asset protection for commercial real estate. The cornerstone of any asset protection plan is having sufficient high-quality insurance commensurate with the amount of risk borne by the owner of a given property. The insurer should be well established, stable, and not at risk of going under with a large claim from any source. Title insurance, property insurance, business insurance, worker’s comp, and business interruption insurance are all additional safety nets and part of a solid asset protection plan.

Pro Tip: The building management company, maintenance company, security company, and janitorial staff should generally all be third party contractors with their own insurance policies. These policies would cover their employees/contractors in the event of potential liability.

The building management company, maintenance company, security company, and janitorial staff should generally all be third party contractors with their own insurance policies. These policies would cover their employees/contractors in the event of potential liability. For example, consider an injury from criminal activity and resulting litigation. A property owner is generally responsible for maintaining a safe and secure property. The owner should consider the generally known crime rate of the property’s surrounding area. Higher crime rate areas should indicate greater security staff and other security measures, such as access restrictions, doors, gates, passcards, video recorder cameras, etc.

Commercial Real Estate Business Partners

In many cases, having business partners is a necessity to maximize financial rewards. However, business partners may unfortunately plant the seeds of destruction of the venture. This is because the liabilities of a given partner may become the liabilities of the business. Additionally, the ownership interest of the partner may become a target for seizure. This action would disrupt the business activity of the venture. Such situations create unnecessary financial burdens on all parties involved in the business.

To avoid these pitfalls, investors should extensively vet potential partners before commencing a venture. The vetting process should include examining their financial and credit status, outstanding debts, liens, marital situation, and other potential liabilities.

Isolate a Partner’s Potential Liabilities 

To effectively isolate a business partner’s liabilities, insert creditor-repelling measures into the holding company’s operating agreement. Such measures may include:

  • Limiting the rights a creditor has to obtain a charging order against a given member of the LLC (no management rights but only distributions)
  • Remaining members’ buyout rights for a reduced price of the creditor’s LLC interest obtained by judgment or court order
  • A spouse release for each member. This document states that the LLC interest the member’s separate property. Therefore, the spouse would not receive any interest or management rights upon death or divorce (except through testamentary grants)
  • Right by members to transfer LLC assets to another entity or jurisdiction for any reason
  • Buyout rights by the LLC of the debtor member’s interests upon any notice of that member’s potential liability (such notice being mandatory)
  • Right to assign or reject any distributions by any member
  • Discretion by members as to how and when to make distributions
  • Other similar provisions

Pro Tip: Once the plaintiff realizes that even by proceeding with the entire claim through judgment and obtaining a charging order (the sole creditor remedy in Texas) the creditor is extremely unlikely to ever obtain any cash whatsoever, the decision by the plaintiff’s legal counsel will be very easy to make: the claim against the LLC will be dropped. 

Bringing Litigation

Once a creditor commences litigation, that party’s counsel will seek all financial documents of the debtor through discovery. This process will require the defendant/debtor/member to disclose the operating agreement, which is a good thing. Here the plaintiff realizes that, even if the claim proceeds through judgment and the plaintiff received a charging order (the sole creditor remedy in Texas), the creditor is extremely unlikely to ever obtain any cash whatsoever. Then, the plaintiff’s legal counsel will often make the easy decision and drop the claim against the LLC.

Obviously, if the debtor has other assets besides the LLC interest, the complainant may pursue those. But the LLC interests will be safe, and business activity may continue unabated, with no disruptions. Even if the plaintiff receives a charging order, the managing member(s) may freely implement the operating agreement’s provisions. These provisions ensure that the creditor never receives payment. This is easy and entirely legal to do. In fact, the creditor may have to pay taxes on paper gains even if not receiving money. The creditor can never have any management rights or seek foreclosure of any LLC interests or sell any LLC assets.

Equity Stripping For Commercial Real Estate

Under U.S.-secured transactions laws, a perfected prior lien will have priority over all subsequent liens in a foreclosure. Therefore, having a solid first and/or second lien to use in the event of a creditor attack is worthwhile. Generally, the first lien is the purchase mortgage or deed of trust from the lender. As equity increases, there may be a need to protect that equity through new liens.

There many ways to equity strip a commercial property. However, the most efficient is an equity line of credit loan (ELOC). The borrower does not need to use or pay interest on the ELOC, unless the borrower wants to do so. However, the borrower should take out the ELOC long before any potential creditor threats to avoid a successful challenge. Then, the borrower can invest the proceeds in other properly-shielded property or purchase ultra-safe offshore assets.

Other equity strip methods include LLC capitalization liens, landlord/tenant liens (if the property owner is using his own building), or any other legitimate lien exchanging cash or other items of value. These methods are complex, and borrowers should not attempt them without qualified assistance.

Pro Tip: There many ways to equity strip a commercial property. However, the most efficient is an equity line of credit loan (ELOC).

Such lien placement places another very substantial barrier between a creditor and pursuit of judgment. This increases the likelihood that a plaintiff attorney will decide to forego the claim. The plaintiff attorney knows that the claimant must wait until a property sells or forecloses before collecting. Furthermore, the owning entity may see its lien completely wiped out, in which case the claimant receives nothing.

Land Trusts for Holding Texas Office Assets

Unfortunately, Texas does not have a separate land trust statute like Florida and Illinois. However, a land trust may accomplish the same goals as using a commercial real estate LLC. The Texas Trust Code governs Texas trusts and does not offer the same protections as in the other states. Therefore, no matter what anyone says, there is no such thing as a statutory “land trust” in Texas.

There are few situations where an entity may use a trust to transfer property interests. Trusts are not legal entities and do not offer liability protection. Examples include privacy requirements, estate planning (succession of ownership), and simplification of transfer (multiple owners consolidated under trustee and trust interests are personal property; deed recording transfer not required). Again, entities should use Texas trusts only in limited situations. Such situations include temporary property ownership and/or shielding a particular transfer from appearing in county records in between transfers to a legal entity such as an LLC. Of course, LLC interests can transfer the same way, without any public disclosure, and LLCs are also an effective estate planning tool.

Legal Counsel

Certainly, a knowledgeable and creative counsel is the most essential tool in asset protection for commercial real estate. A qualified attorney will tailor the plan to an investor’s particular needs and potential risk. Is there a high-risk property with a substantial risk of litigation by a tenant or invitee? Does the business partner have a separate high-risk venture? Does the partner face a significant risk of potential litigation for their interest in a company? Can the plaintiff seek partition of the property or obtain control of that partner’s interest in the LLC? Is there a potential marital dissolution on the horizon? Might the spouse demand a share or control of the business or property? Does the partner’s other property have tax liens against it? Does the investor need significant anonymity for this and other reasons, such as other potential creditors?

All these issues require a custom strategy implemented to maximize the likelihood that assets will not be discoverable. Furthermore, if discovered, this strategy creates barriers that discourage the creditor and their attorney from continuing.

Pro Tip: Certainly, a knowledgeable and creative counsel is the most essential tool in asset protection for commercial real estate. A qualified attorney will tailor the plan to an investor’s particular needs and potential risk.

In addition to planning and implementing an asset protection strategy, an attorney can act as the trust’s agent. For example, the attorney may act as a signatory on contracts, a negotiator in disputes, a representative in business deals and litigation, and as an attorney in fact in certain situations. Dependable counsel is an indispensable asset. Your counsel can build that wall between an investor’s valuable assets and those who would seek to confiscate them for any number of reasons. Many times, these litigations are nefarious and opportunistic; suing a company just because the investor has the deepest pockets of all other potential defendants.


Disclaimer:

This guide provides educational and general principles and in no way represents a proposal, legal advice, or specific recommendations as to any party which may obtain it. In this guide, the treatment of the law is non-specific and is not intended as a comprehensive discussion of all relevant issues that may be involved in your situation. You are strongly urged to seek the advice of experienced legal counsel to review your specific goals, financial situation, and circumstances.

All warranties as to this guide are hereby expressly disclaimed, and absolutely no liability will accrue to any party that drafted or is providing this guide to any person or entity resulting from any use of the information contained herein. You hereby release and hold harmless the drafter of this guide and any provider of this guide for any financial or other loss that may occur as a result of the recipient’s utilization of any information contained herein. Your use of any information contained in this guide is carried out solely at your own risk, and you are again cautioned to consult a legal professional before doing so. If you have any questions, please contact us at [email protected]

Prepared for: CXRE, LLC. By: Bruce Belenky, ESQ. BELENKY LAW FIRM PLLC.

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CXRE » Commercial Real Estate Investment » The Ultimate Asset Protection Planning Guide for Commercial Real Estate Investors – Updated for November 2019