As Business Lawyers we are often called upon to assist our clients with what’s perceived as a “simple” matter. Case in point, a property owner calls and asks us to assist in the transfer of a commercial property that they’ve owned in their individual name for years. The caller met with a “friend” who recently bought a property and as part of the process was counseled to take ownership through an LLC (limited liability company). The friend was shocked to learn that the caller didn’t own his property through a corporation or LLC in order to protect himself from personal liability and to put some additional legal separation between the real property and the business that the caller also operates at the property. The caller expresses urgency in having us do a “quick” deed transferring the property to an LLC.
For our purposes we will assume that the entity being used is an LLC, without delving into the various issues that need to be taken into consideration when deciding on the appropriate entity. I will focus on a few crucial issues regarding the transfer that need to be considered prior to drafting a deed and running to the County Clerk’s office to record it.
Our first question: “Is there a mortgage on the property?” The caller’s response: “Yes there is, why does it matter?” Since there’s a mortgage the loan documents for the mortgage need to be reviewed, regardless whether it is a loan from a private party or an institutional lender (“Bank”), in order to determine if the Bank’s approval is required prior to transferring the property into the LLC.
Inevitably when we review the loan documents there’s a provision in the loan agreement, promissory note and/or mortgage that prohibits the property from being transferred without the Bank’s approval. What happens if I transfer the property and don’t get the Bank’s approval prior to doing so? The loan documents typically provide if the property is transferred without the Bank’s approval the debt is deemed to be in default and the balance is accelerated (the entire balance becomes immediately due and payable). This unintended result can be if the property is transferred without checking the loan documents and securing the Bank’s written approval for the transfer.
If the Bank approves the transfer it’s often conditioned on the borrower supplying acceptable current financial information for the current owner(s) and the LLC; the borrower obtaining an endorsement or new title insurance policy in the name of the LLC and including the Bank as an insured party; modification of the existing loan documents to include the LLC as a party; and the principals of the new entity signing personal guarantees. You should keep in mind that the costs of addressing the Bank’s requirements will be borne by the borrower.
Next question: “Do you have a title insurance policy for the property?” The caller asks, “Why are you asking about title insurance, all I want to do is transfer the property out of my name into an LLC?” If there’s an existing title insurance policy and the property is transferred from the named insured to a separate entity, such as the LLC, it’s possible that the insurance policy will provide that coverage terminates upon the voluntary transferred of title. In fact, there’s a New Jersey Supreme Court case, Shotmeyer v. New Jersey Realty Title Insurance Company, 195 N.J. 72 (2008), in which the Court determined that a title insurance policy lapsed when real property was conveyed from a general partnership to a separate and distinct limited partnership even though the individuals that owned the entities were the same. Therefore, a determination will need to be made whether an endorsement or amendment can be added to the existing title insurance policy, or if a new title insurance policy needs to be obtained.
Along with addressing title insurance coverage, an updated title, judgment and lien search should be performed to determine if there are any liens or judgments against you or the property that you may not be aware of. Unless the existing liens and judgments are released they will continue to attach to the property after it is transferred to the LLC. Interesting fact, under the current Uniform Commercial Code in effect in New Jersey a UCC1 financing statement (lien form) does not require the debtor’s signature prior to the lien being filed. As such a lien can be filed without you knowing about it. Also, UCC1 liens can also be discharged by filing a termination statement, which doesn’t require the signature of the party that holds the security interest. In addition, the judgment search may reveal that a judgment you satisfied years ago is not reflected as satisfied in the public records. If any of these inappropriate or inaccurate items are revealed in the searches action should be taken to address them prior to the property being transferred.
As is common with many things in life, there’s often the “simple” and the “right” way to do things. As illustrated above if one takes the simple path by forming an LLC, and preparing and recording a deed without determining the impact these acts will have on existing mortgages and title insurance this can turn into a financial nightmare. Laddey, Clark and Ryan, LLP’s Business Law and Commercial Real Estate Practice Group is here to help you with your business and commercial real estate needs. Please visit us at www.LCRlaw.com