Posts by: leechen

Til Death Do Us Part – Marriage and Asset Protection

August 15, 2017 Asset Protection Comments Off on Til Death Do Us Part – Marriage and Asset Protection

The question of whether a spouse can be held liable for the debts of the other spouse is often asked from married  (or to be married) couples, but the answer is not uniform and depends largely on  the laws of the state where you reside.

MOST STATES – COMMON LAW TREATMENT

The large majority of states that are NOT one of the nine “community property” states discussed below operate under the “common law” system, derived from Great Britain.  In these common law states, the liabilities of married couples are generally determined under the “title” theory, meaning whichever spouse is on title for the asset owns the asset, and whichever spouse was responsible for incurring the debt is solely responsible for that debt.  Spouses in common law states are generally not jointly liable for debts unless they both are involved in procuring the debt as a “joint debt.”  As a result, if a married individual in a common law state alone incurs a debt, the creditor would generally be limited to recovering from that individual’s assets only, and no recovery could be made from assets titled in the name of that individual’s spouse.   On the surface, this would encourage married couples to segregate their finances so that valuable assets are held in the name of the spouse with lessor risk, and corresponding debts in the name of the spouse with higher risk.  However, these rules are very state specific and, of course, moving your assets around when a creditor is already on the horizon raises fraudulent conveyance concerns, and so any asset protection planning should be done before the need arises.

Some common law states create an exception to the “title” rule for debts that are deemed for “necessities” or for “family expenses.”  In those states, spouses may be jointly liable for debts that are necessary for the family such as education, household, or medical debt even if the debt was obtained by one spouse only.   States also vary in how broadly they define debts deemed to be “necessities” or for “family expenses,”  and so it is important to understand how your state defines these terms to understand under what circumstances a creditor can attach the assets of a both spouses for the debts of only one.  Other states impose joint liability if the liability was created when a spouse was deemed to be acting as an agent of the other spouse, and so anyone concerned about spousal liability would need to familiarize themselves with the rules unique to their state.

TENANCY BY THE ENTIRETIES

In states that recognize “tenancy by the entireties,” assets owned jointly by the spouses as “tenants by the entireties” are deemed to be owned by the couple as a whole, and not owned by each spouse individually.   In these jurisdictions, a creditor of one spouse is generally unable to attach property owned “by the entireties” unless the other spouse also joined in the creation of the debt.   Therefore married couples in states that allow “tenancy by the entireties” often hold valuable real estate in this manner which can provide effective asset protection against creditors of just one of the spouses.   Again, these rules are not uniform as some states may find that a debt entered into by one spouse is nevertheless a joint debt if the non-debtor spouses knows, benefits, consents or ratifies the debt.

COMMUNITY PROPERTY

In the nine community property states (CA, AZ, TX, WA, ID, NV, NM, WI, and LA) which derives their marital property law from the Spanish system, each spouse in a marriage is deemed to own a ½ interest in assets that are deemed community property.  Since each spouse has a half-interest their individual debts could be attached and satisfied by a creditor against their 1/2 interest.  Therefore, by contrast to the common law system which relies heavily on “title,” the key component in community property states is not who owns the property, but how the property is characterized.   For these reasons, experts generally agree that community property states are more creditor friendly than their common law counterparts.  For example, assume a couple consisting of a primary wage earner and a homemaker.  The wage earner purchases a house during marriage using wages from employment, and takes title in the wage earner’s name only.  The homemaker then gets into a car accident which is not fully covered by insurance.  The resulting liabilities would obviously depend on the specific state but generally, in a common law state, the house could be protected from the homemaker’s liabilities because title is held in the wage earner’s name only, whereas in a community property state, ½ of the house could be exposed because the property would likely be deemed community property which the homemaker owns a ½ interest.   Therefore, marriage in a community property state could effectively expand the potential assets that creditors of either spouse can reach to the extent a married couple acquires assets characterized as community property.

Since exposure of assets in community property states depends on characterization, there is an incentive for married residents in community property states to consider marital property agreements that alter the characterization of assets (i.e. pre-nuptial or post-nuptial agreements).   The procedural requirements to form an enforceable marital property agreement, and the extent to which such agreement will protect your assets will depend on the laws of the state.  Therefore, consulting with an expert who understands these nuances in the respective state is essential to ensure that any asset protection goals are maximized.

Any married individual concerned about asset protection would be well served to understand the specific rules in your state governing the exposure of your assets to creditors, what tools exist in your state to mitigate your exposure to spousal liability, and how to utilize these tools in a manner that maximizes your protection in the event of an unforeseen liability.   Most important is the need to engage in this planning before it is actually needed as any planning done when a creditor is already in the fray may be vulnerable to attack as a fraudulent conveyance.

Legal Tips for Wholesaling Real Estate

July 18, 2017 Business planning, Real Estate Comments Off on Legal Tips for Wholesaling Real Estate


Many real estate investors regard wholesaling as a way to learn how to evaluate deals and develop your real estate network.  It is also a method to profit from investing in real estate without requiring significant up front capital.  Wholesaling is a strategy whereby the wholesaler enters into a purchase contract with a seller of real estate and then assigns the purchase contract to another third party who will typically rehab the property and flip it for a profit (at least that is the goal).

Although most investors regard wholesaling as involving less risk than, for example, the flipper who is rehabbing and selling the property, there are always risks in any transaction, and so the purpose of this article is to identify some of the common legal issues to look out for in your wholesale deals.  This article is not designed to teach you the strategies for being a successful wholesaler, such as how to find properties, how to approaching homeowners, etc., but instead, focuses on some of the legal aspects of wholesaling that investors should be aware.

Licensing Issues:  Be aware of potential licensing requirements for your state:  Different states define the scope of activities that require a license differently and so you should be aware of what activities are regulated by your particular state and act accordingly.  For example, California generally defines a real estate broker as someone who sells, buys or negotiates for another with the expectation of compensation.  If your activities in California meet these elements, then be advised that you may need to be licensed as real estate agent.   Any questions regarding state licensing requirements should be directed to an attorney with knowledge of the requirements of that state.

LICENSING ISSUES

Understand the Rules & Procedures Governing Real Estate Transactions in your State:  Many states have unique laws, forms or disclosure requirements for real estate purchase transactions.  For example, in California, a seller is required to provide a transfer disclosure statement and if the property is in foreclosure, there are additional required disclosure requirements.  Failure to abide by the rules that are required in your state could cause legal issues down the line in your transaction.  You don’t want to have a seller or your end buyer come back later raising an issue with the transaction that could have been avoided had you followed the proper procedures for real estate transactions in your state.

DISCLOSURE & TRANSPARENCY

Be Transparent as to your Role in the Deal:  If your intent is to wholesale the property during escrow, the homeowner should be well aware in writing that your intent is to assign the deal to a third party for profit, and the contract language should give you a unilateral right to assign without requiring the consent of the homeowner.  Most standard form purchase agreements you get from realtors do not have this language and so an amendment or specially prepared form may be necessary.   On the buyer’s side, you should be very clear in your written agreement with the end buyer as to what you will be responsible for and what will be the responsibility of the end buyer.  For example, are you going to do an analysis of after repair value (e.g. running comps and estimating repair costs)? Run title?  Do an inspection?  What happens to your earnest money deposit once you assign the contract to the end buyer?   Your agreement should clearly specify in detail what your specific obligations are in the deal, where your obligations in the deal ends, and what the end buyer is expected to do to close the deal.  It is better to have these details on who does what expressed clearly in writing rather than rely on assumption.    Most importantly, you should include language that fully releases you from any further obligations or liabilities in the deal to ALL parties once you complete the assignment to end buyer.

CONTINGENCY CLAUSES 

Make Sure Your Contingencies are Clear.  This should go without saying, but depending on the specifics of the particular deal, it is important to properly set the expectations early for all the parties involved.   I typically advise clients who wholesale properties to have a good understanding of what their potential end buyers want in a deal in terms of location, spread, contract language, due diligence items, etc.  I also encourage individuals wanting to pursue wholesaling to develop relationships with rehabbers as early as possible, preferably before getting a property under contract, so that they have a good idea of whether they will be able to successfully complete the assignment as intended.    It is highly recommended to have your team of professionals such as realtors, contractors, appraisers, etc. in place to provide accurate feedback as you analyze the merits of your deal.  Finally, have an attorney’s fees clause in your agreements so if you have to pursue legal action to enforce the agreement or your contingency clause, you preserve the right to seek your attorney’s fees.

Of course, making sure you are covering yourself legally is just one detail for successful wholesaling.  Finding the right properties, learning to negotiate with homeowners, and developing a network of professionals to assist you during the wholesaling process are all necessary aspects for successful wholesaling, but making sure that you are covering your bases legally will help ensure that your wholesale deals proceed smoothly with minimal possibility for conflict.

The Realities of Litigation

June 27, 2017 Business planning, Law, Litigation Comments Off on The Realities of Litigation


For most people involved in a dispute, declaring the words “See you in Court!!” can seem like the perfect threat or even feel therapeutic at the least. Some even presume that by stating “I’m going to sue you” is like declaring nuclear war against the other side and the person or company that wronged you will certainly want to ‘settle’ because you have scared them with a lawsuit.

However, people who have actually been participants in litigation soon realize that there is no such thing as “inexpensive litigation,” and many individuals, fueled by the passion of a person scorned, proceed hastily to the courthouse seeking vindication or retribution without having a full understanding of the realities that they are getting themselves into.

Certainly, one of the great hallmarks of our society, and what separates the American system from many others around the world is an independent judiciary. But again, the media frequently oversimplifies what is actually involved in the legal process with its sole focus on sensationalizing the outcome thereby conveying a misleading impression of the actual litigation process.   Here are a few misconceptions I frequently encounter with clients about the litigation process include the following:

  1. Are you ready for the PROCESS? Unless you are in small claims, you generally don’t just file a lawsuit and then get to see Judge Judy the very next day. Media usually focuses on “trials” only, but ignores the months (usually years) of pre-trial procedure needed to get to that point.    Litigation usually begins with a “Complaint” which begins the “pleading” phase where the parties set forth their allegations and responses in defense. Sometimes there could be challenges to the pleadings through the motion process, which add additional expense and delay. Once the pleadings are done, then the parties have the opportunity to require other parties to the lawsuit to answer questions, produce documents, or take testimony of witnesses (the “discovery” phase). It should come as no surprise that parties to litigation are not always so eager to provide information that may hurt their case, and so the discovery process can often take months or years with parties jockeying in court over who should get what.   Assuming the parties have completed discovery, that does not necessarily mean you go to trial.   Trials only occur when there are actual factual or legal issues in dispute which requires a judge or jury to determine, and the reality is that most lawsuits do not go to trial. Although the cost of litigation varies depending on the location and issues involved, what I usually tell clients is the cost to go through these procedures to litigate a normal civil matter from Complaint up to but not including trial, doing a minimal amount of work, can easily run between $50,000 to $100,000. Preparing for and conducting a trial can substantially increase these costs and so unless you’ve retained an attorney on contingency, the expense and delay litigation is definitely an important consideration for most litigants.
  2. Does the Opposing Party have Assets to Satisfy Your Claim?  Usually this is the first question I ask a client contemplating litigation, and many times it is question the client hasn’t considered. It makes no financial sense to pay tens to hundreds of thousands of dollars on a case if the defendant has no money.  Although I’ve had my share of clients walk into the office wishing to sue “on principle” or “just to make a point,” these moral considerations usually get thrown out the window very quickly once we begin to discuss the costs that will be incurred to get them to where they want to be.   So unless the opposing party has significant, identifiable assets that may be exposed in a lawsuit, or there is sufficient insurance to cover the claim, many potential litigants find themselves having no remedy for their claim because the opposing side is essentially “judgment proof.”
  3. Do you realize how unpredictable litigation can be? This should go without saying, but I spoken with plenty of people contemplating a lawsuit express confidence that a judge or jury would find them in the right. In litigation, it is less about who is wrong or right and more about what you can prove. Court decisions are ultimately made by people who come from all types of backgrounds and from all walks of life, and attorneys in high stake cases often employ professional “jury consultants” and perform “mock trials” to gauge how a jury will likely view their case. Despite all the money that is spent on attorneys, consultants, experts and the like, even the best attorneys with the greatest of resources lose cases, and most of us have probably followed cases in which we were surprised by the outcome. From a legal perspective, the reason there are trials is because there are issues of law or fact in which “reasonable people can differ.” If every issue in a case was a “slam dunk,” then there would be no need for a trial.

For these reasons and more, I consider litigation to be the option of last resort. Although the media likes to portray litigation and trials as dramatic and full of suspense (which it certainly can be), they leave out the cost and the time consuming process.

Consider interviewing several litigation firms before embarking on your lawsuit and make sure you weigh all the pros and cons of a long draw out lawsuit. It doesn’t mean litigation shouldn’t be a tool, threat or productive option in your dispute, but just go into the process with your eyes wide open.

What You Should Know about Administering a Family Member’s Estate

May 23, 2017 Estate Planning, Law, Retirement Planning Comments Off on What You Should Know about Administering a Family Member’s Estate

Most of us will, at some point in our lives, be called upon to administer the estate of a departed family member or loved one. While it may seem like an honor to have been entrusted with this responsibility, the reality is often it is a thankless, time consuming job, and even more so if there are disagreements and disputes among the heirs or beneficiaries of the deceased.

Being asked to shoulder the responsibility of administering a decedent’s affairs while still mourning their loss can be challenging. The precise rules and procedures that apply will depend on whether the decedent had a trust that was fully funded, whether probate will be necessary because the either decedent did not have a trust or did not fully transfer all relevant assets into the trust.

It will also depend on which state laws apply as well as the value of the estate. Keep in mind that it is impossible to provide an all-encompassing checklist that applies to each family situation and the procedures may vary greatly depending on if the decedent had a will or a trust. However, here are some general guidelines to keep in mind, some of which may or may not apply depending on the situation:

  1. Seek Professional Advice.   This is something you may only do once in your lifetime and Google is not going to give you all the answers you need.  Also, keep in mind you do not have to go at this alone. Depending on the value of the estate and its complexity, you may want to employ the services of professionals such as attorneys, CPAs, appraisers, etc. to assist in navigating your responsibilities. Typically this would entail an estate attorney, a CPA knowledgeable in estate and income taxes, and a financial advisor, although additional professionals may be needed depending on the situation. Usually, these fees would be paid from the decedent’s estate and so there should be no financial disincentive to seek help if needed. There may be certain actions, decisions, procedures or deadlines that need to be met in a timely manner, which could impact the ability of heirs or creditors to make claims or challenges to the estate. Most people are not aware of these rules and deadlines and so getting the right advice from the start may be good protection for both you and the estate.
  2. Inventory and Secure the Decedent’s Assets & Important Documents. A trustee or administrator of an estate is charged with the duty to assemble, inventory and safeguard the decedent’s assets and important documents. In the immediate aftermath of a death, it could be a chaotic situation with visitors and relatives coming and going and, as the representative of the estate or trust, it is incumbent on you to safeguard the important assets and documents. You will need to determine whether the decedent had a will or trust, and assemble all important documents, contracts, bank accounts, financial accounts, safe deposit boxes, investment accounts, unpaid wages or other income sources, mortgages, insurance policies, retirement accounts, social security or other government benefits, pensions, real estate, businesses, prior tax returns, digital assets (email, social media accounts), etc. of the decedent. It may take some investigation into the files of decedent or interviewing the family members to uncover all potential assets and liabilities, and don’t assume decedent told you everything there was to know. A separate bank account will likely need to be set up for the estate or trust, and never comingle your personal finances with the estate/trust finances. You will need to obtain several certified copies of the death certificate in order to establish control over certain accounts held by third party custodians/banks. Some assets such as real estate may need to be appraised to determine the fair market value for purposes of estate taxes, reporting, or for distribution.
  3. Gather and Assemble a List of Decedent’s Creditors. This does not necessarily mean that you will immediately pay every bill as soon as it arrives. Rather, there could be other expenses that take priority such as funeral expenses or federal and state taxes. As a trustee or administrator of the estate, you could get into trouble by paying expenses that then leaves the estate unable to meet its tax or other priority obligations.   It is important to try and get a broad picture of the Decedent’s overall financial situation, including factoring in potential tax liabilities, in order to establish a game plan for administering the estate or trust and paying creditors. Of course, some debts such as mortgages or car payments need to be timely made to prevent the account from going to default, but have a concerted strategy for handling Decedent’s creditors. If it appears that the estate may not have sufficient assets to cover all liabilities, then professional assistance or assistance from the courts may be needed to determine how to prioritize payments.
  4. Notify Decedent’s Heirs and Beneficiaries. Some states have time requirements on when heirs and beneficiaries should be notified and whether they are entitled to receive a copy of Decedent’s will or trust. Their ability to bring challenges to the trust or estate may depend on when they were first notified and so seek help to determine the requirements in your situation and document your communications with heirs and beneficiaries.
  5. Manage the Assets of the Estate Prudently and Obtain the Consent of Heirs or Beneficiaries for any Major Actions. As the trustee or administrator, you are a fiduciary and must act in the best interests of the beneficiaries or heirs. You generally have a duty to manage and invest the assets as a reasonably prudent investor would and can be held personally responsible for failing to do so. Therefore, seek the advice of legal and/or financial counsel regarding any issues with managing or investing the assets of the estate, and if a decision needs to be made regarding an important asset (such as selling the asset, making significant improvements to real estate, etc.), consider obtaining the written consent of all beneficiaries before authorizing such action.
  6. Distribute the Assets to the Heirs/Beneficiaries. Once all the creditors and taxes have been paid and the estate is in a position to be distributed to the beneficiaries, an accounting may need to be performed and approved by the heirs/beneficiaries, and then the assets of the estate/trust may be distributed and estate or trust closed.

Again, keep in mind these are only general guidelines for administering trusts and estates and there may be specific state or federal requirements and deadlines that will apply to your situation. If you have a particularly large estate that may implicate state or federal estate taxes, there are likely additional requirements and deadlines and so it is recommended that you check with appropriate professionals as soon as possible for large estates.

For smaller estates or assets with lower value that are not held in trust, there may be other options for distributing those assets without the need for probate.   The rules and procedures can be rather complex depending on the state and the situation and so make sure you consult with appropriate professionals to ensure you are complying with your responsibilities as a fiduciary for the estate/trust.

What Do I Need to Know About Title Insurance

April 4, 2017 Real Estate Comments Off on What Do I Need to Know About Title Insurance

We all know that title insurance is a necessity when purchasing real estate, but many do not have a sufficient understanding of what title insurance is really for and steps we can take to deal with title insurance companies to prevent being embroiled in a title dispute. Litigating title disputes can often be long, expensive, and often difficult to predict the outcome with any certainty. For that reason, having a solid grasp of what title insurance can do and cannot do is important for any would be purchaser of real estate.

The condition of title is one of the most important due diligence items for a buyer of real estate.   Purchasers usually want title to real estate to be clean, or as lawyers describe it to be “marketable.” Marketable title does not mean title that is completely free from any liens or claims, but merely title that is sufficiently free from doubt that an informed and reasonable buyer would accept it. For example, some legal descriptions for properties will exclude mineral rights, or contain easements for sewer, gas, or other utility lines. Technically, these are claims or “encumbrances” against title, but most would not consider these types of claims to be a sufficient “cloud” on title to render it unmarketable since those types of claims typically do not affect a buyer’s right to enjoy the property.

WHAT IT A PRELIMINARY TITLE REPORT?

Title insurance does not remove defects nor does it guarantee marketable title, but merely provides a means of recovery if title does prove unmarketable for a reason that is covered under the policy. In a typical real estate transaction, one of the initial first steps in escrow is that the title insurer will issue a “Preliminary Title Report” (“Prelim”). This is a crucial document for buyers to understand as part of their overall due diligence.   Contrary to popular belief, a Prelim is not a guarantee of the condition of title and title companies are generally not liable for errors appearing on the Prelim. I’ve seen cases where title insurance companies made mistakes on the Prelim, but unfortunately there was no recourse against the title insurance company because the Prelim is merely an offer, not a binding representation of title.  Therefore, although Prelim is a good starting point for conducting due diligence on the condition of title, but depending on the property, additional due diligence may be needed above and beyond what appears on the Prelim. Additionally, following a Prelim the Title Company issues a commitment for title and issues their title policy off of this commitment. It is the terms of the actual policy that comes from the Title Commitment that you need to be most certain about as the Prelim is not binding on the insurance company.

UNDERSTAND THE EXCEPTIONS TO YOUR POLICY

The most important part of reading the Prelim and the Commitment that follows is understanding the exceptions. The Commitment will list the exceptions which are items that would not be covered under the policy. Exceptions may be specifically listed, such as existing mortgages, unpaid taxes, federal tax liens, recorded easements, etc.   There are also general exceptions that are typically listed as an Exhibit to the Prelim or Commitment as a “Schedule B” Exception. These exceptions are usually described very generally and in legalese (i.e. most purchasers don’t pay attention to it). However, it is important for the purchaser to have a general understanding of these general exclusions so that if there is a potential issue on the property that is possibly excluded under these general exceptions, the purchaser can consult with the right professionals (lawyers, inspectors, surveyors, etc.) to determine what are the risks, and what steps can be taken to fix the defect (or else re- negotiate the price or cancel the deal).

For example, boundary disputes and encroachments from neighbors are typically not covered under a title policy. If the physical inspection of the property shows some doubts as to the boundary lines (e.g. no walls or physical marker showing the boundary lines or trees along the property line that create doubt as to whose side of the property it is on), then further due diligence, hiring professionals, or conducting a survey would be recommended. Even though standard policies may not cover certain risks, additional coverage might be available to cover these types of claims for an additional fee if you inquire.

Furthermore, standard title policies typically cover only matters in the public record (recorded liens, easements, judgments, etc.) and do not cover issues not shown in the public records.

As such, the Prelim and Commitment should not be the sole resource for determining whether there are issues with title, but if there are any doubts, these should be independently researched, or any doubt should be addressed directly with the seller and/or title rep.   For example, if the seller has been sued, or owes taxes to the IRS, these issues may not appear on the Prelim or Commitment if nothing has yet been recorded, but those issues could definitely affect your interest in the property, and so consider confirming with your seller that they are not aware of any unrecorded interests that could affect title or conduct your own independent due diligence. In addition, Prelims and Commitments may disclose the existence of a lien, but fails to provide specific information about its details, and in those cases, actual copies of the lien documents should be obtained from title or the seller.

GETTING A SPECIAL ENDORSEMENT

Any questions regarding the condition of title should be discussed with the title officer and/or attorney so that further investigation can be done to determine what can be done with respect to any title issues that arise during escrow. Sometimes a title insurer may be willing to issue a “special endorsement” to cover a particular title issue that would not otherwise be covered under the policy, but it is incumbent on the buyer as part of his/her due diligence to inquire about these issues, and of course, preferably during the due diligence period while the buyer still has the right to negotiate or cancel the deal. These types of inquiries should be made in writing so there is a record documenting the discussion.   I have experienced situations where a title insurer initially denies coverage for a claim stating that they were not aware of the issue, but then had to reverse course when presented with written evidence that the issue was discussed with the title company during escrow.

Finally, as with any insurance company, it is important to make sure you are working with a reputable company that will be there for the long haul. Getting a policy on the cheap from an unknown company will be useless if that company goes out of business. Choice of title companies are negotiable, although if the seller is paying for title insurance, they will usually insist on their own title company. Make sure that company is legitimate and has an established history and track record.

Fortunately, most homeowners will never need to make a claim on their title insurance. However, anyone who has experience litigating these types of disputes knows that the outcome is frequently hard to predict, and is often determined by which party has the most resources. If a claim ever arises requiring litigation, you’ll want to have the resources of an insurance company defending your interests, and in order to maximize that possibility, it is important to perform your due diligence on the property, on the title insurance company, and the details of the policy they propose to issue for your property.

Alternatives for Securing Your Loans or Investments

March 7, 2017 Asset Protection, Business planning, Law Comments Off on Alternatives for Securing Your Loans or Investments

We often advise clients who want to loan money or participate in an investment to “get adequate security” for their investment. The purpose of getting additional security for your loan is so that you have something else that you can go after if the loan goes south.

Ordinarily, if your loan is “unsecured,” it generally means that if the investment tanks, then your only remedy would be to sue the debtor and go through the potentially expensive process of litigation in hopes that you can get a judgment against the debtor, and perhaps most importantly, that the debtor will then have assets from which you can collect.

In our experience, if a debtor has defaulted on your investment, they are likely experiencing financial issues as a whole, and will unlikely have assets for you to recover from even if you prevail in your lawsuit. Moreover, a debtor having financial issues and/or without assets is a likely candidate for bankruptcy, and for those reasons, investors who are reduced to having to resort to the court system to remedy a failed investment are often just throwing good money after bad.

In general, real estate with sufficient equity to secure the investment is the best form of security for the primary reasons that real estate is immovable, and there is a well established public record for recording and determining rights and priorities to real estate.

However, if securing your investment with real estate is not an option, that does not mean your investment must be unsecured. In fact, virtually any type of property or asset can serve as collateral for an investment. Unlike real estate, the process and laws for securing your investment using “personal property” as collateral will depend on the type of property as well as the applicable state, local, and sometimes federal law that apply.   Examples of personal property that can serve as collateral for your loan include the following:

  1. Interests in Inventory, Equipment, or Fixtures – If you are lending to a business and that business has assets, those assets could likely serve as security for your loan. In general, this would require an additional “security” agreement which specifically identifies the assets that are being offered as security for the loan, which then must be “perfected” usually by filing a UCC-1 Financing Statement with the Secretary of State for the state where the business is located. This procedure is most often used by banks and other financing companies for business loans that are not secured by real estate. The benefit is, like real estate, the office of the Secretary of State serves as a central resource where anyone can access to determine the existence of liens against the assets of a business and the priority of those liens.
  1. Interests in Stock or interests in LLCs – If the debtor owns interests in his/her own corporation or LLC, the interest in the corporation or LLC could serve as security for a loan. This is most often accomplished by a “pledge” agreement whereby the debtor offers his/her interests in the corporation or LLC as collateral for the loan. One drawback for stock or LLC interests is, unlike real estate or other asset classes, there is no central resource like a recorders’ office or secretary of state for determining if there are competing or priority claims against privately held interests in businesses.   In addition, a pledge agreement doesn’t mean much if the entity itself has no assets and so adequate due diligence on the entity that is being pledged is essential.
  1. Interests in publicly traded securities and securities accounts – Interests in stocks or other securities held by a brokerage can also serve as collateral for a loan. Usually, this is achieved by having the parties to the loan enter into an agreement with a third party custodian that holds the account (sometimes called a securities intermediary) which provides that upon a default on the loan, the third party custodian will deliver the asset to the creditor without further consent by the debtor.
  1. Interests in Intellectual Property – Interests in Trademarks, Patents, Copyrights, and even Trade Secrets can serve a security for a loan, although the procedures for perfecting these interests in intellectual property will differ and it is often difficult to place a value on intellectual property for purposes of determining whether the value is adequate for the loan.
  1. Interests in Tangible Personal Property – Virtually any item of personal property of value (such as jewelry, equipment, vehicles, etc.) can serve as security for a loan. Usually this would entail delivering the property to a third party who holds the asset similar to an escrow or consignment subject to performance of the terms of the loan. For assets which ownership is evidenced by some certificate of title, there may be a department or organization which provides for registering your lien (e.g. the Department of Motor Vehicles).

Securing your loan or investment with personal property is just one part of the due diligence that you should be performing when considering any particular investment. As this article demonstrates, the documents and procedures necessary to document, establish and perfect these secured transactions may vary widely and so you want to make sure that you follow the correct legal procedures and that your security documents are properly drafted so ensure that your loan or investment is, indeed, secure.

Which State’s Law Applies in a Lawsuit?

February 14, 2017 Asset Protection, Business planning, Corporations, Law, Litigation, Real Estate, Small Business Comments Off on Which State’s Law Applies in a Lawsuit?

We frequently hear from clients who have been told by others that they should incorporate in Nevada (or other states outside of their home state) in order to take advantage of their favorable laws.   We have seen many individuals persuaded into incorporating in a state outside of their home, only to complain about the cost and complexity of the structure which ultimately had to be unwound.

This is not to say that incorporating an entity in Nevada or Wyoming should never be considered as part of an asset protection strategy. One primary reason for incorporating a Nevada or Wyoming entity is arguably due to their strong “charging order” protection.   The charging order is a concept protecting an LLC owner who is sued and held liable for something unrelated to and “outside” from the LLC from then being able go and take that LLC interest or the asset held by the LLC.   For example, if you’re cruising on the highway over the weekend and get into a major accident causing serious injuries, the charging order could prevent or hinder the injured plaintiff from seizing your assets held in your LLC.

However, the myth that we often hear from clients is that because states like Wyoming or Nevada have strong asset protection laws, they should take advantage by incorporating these entities into their structure even if they don’t own assets or do business there. What is often omitted from the conversation is whether Nevada or Wyoming law will actually be applied if there is no connection between the lawsuit and Nevada or Wyoming.

Since we are a union comprised of fifty states with different laws, there is an incentive to try and take advantage of states that have more favorable laws. Courts generally discourage this type of “forum shopping” where people try to use the favorable laws of one state even if they have no actual connection with that state.

One of the ways courts deal with these types of cases is by applying a set of rules called Conflicts of Laws. It is an area of the law that allows a state to determine which laws will apply to a case when the laws of multiple states could potentially apply.

For example, lets say a California resident is driving in Nevada on his way to Vegas and collides with a Colorado resident causing catastrophic injuries. Where should this type of lawsuit be filed and which of these three state’s laws should we apply? Because these types of circumstances can be so varied depending on the residency of the parties and the location where the events resulting in a lawsuit occur, it is sometimes difficult to predict where a lawsuit should be and what state’s laws should apply. This is further complicated by the fact that states have different Conflicts of Law rules.

Here are some general rules that courts will usually apply depending on the type of case. Examples include the following:

  1. Personal Injury or Fraud: Generally the law of the state where the wrongful act causing the injury or fraud occurred will be the law that should be applied. For example, if the accident or fraudulent conduct occurred in Nevada, that is an indicator that Nevada law should be applied;
  2. Personal Property (damage or theft): Where the personal property was located when the act causing the theft or damage occurred may determine which state’s laws should apply;
  3. Real estate: The state where the real estate is located will often determine which state’s laws will apply in a dispute relating to real estate;
  4. Contracts: Where the contract was entered or where the principal events necessary to form the contract occurs. Keep in mind that many contracts have provisions governing which state’s laws or courts will be used in the event of a dispute. These types of “forum selection” or “choice of law” clauses are often enforced by courts, unless there is no substantial or reasonable relationship with the chosen state. For example, if you are in California and you enter into a contract with someone else in California and all the activities relating to the contract occur in California, it is unlikely that a California court would enforce a provision that says Delaware law should apply even if you included such a provision in your contract.

These are just some very general guidelines as courts may consider additional factors in any given case. Hence, the outcome in any particular case is often difficult to predict with any consistency.

Therefore, before you decide to set up a structure that includes incorporating in a state which you have little or no connection with, make sure you understand not only the purposes for choosing that particular state, but perhaps even more importantly, its limitations.     Don’t assume that if you incorporate your entity in Nevada, that you will necessarily get the benefit of Nevada’s laws, especially if you do not live in Nevada.

Court Rules Against California Franchise Tax Board on Overreaching Franchise Tax

January 24, 2017 Business planning, Small Business, Tax Planning Comments Off on Court Rules Against California Franchise Tax Board on Overreaching Franchise Tax

On January 12, 2017, an appeals court in California ruled, in a closely watched case of Swart Enterprises, Inc. v. Franchise Tax Board (Appeals Case F070922), that a non-resident of CA was not “doing business in California” and therefore not liable for California Franchise Taxes merely because it owned a passive investment in California.   Although this ruling may not have much impact on California residents who own and direct investments from California, it does signify the Court’s willingness to impose some limitations on California’s ability to tax under its expansive definition of “doing business in” California.

California imposes a minimum franchise tax of $800 for every corporation (or LLC) “doing business within …this state.”   Revenue and Tax Code § 23101 defined doing business as “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.”

Beginning in 2011, the California Franchise Tax Board (“FTB”), adopted a policy whereby it would impose the minimum $800 franchise tax for any LLC or corporation outside of California if they were deemed to be “doing business in California.”  The policy was summarized in Publication 689 from the Franchise Tax Board, and used the example of a California resident (Paul), who formed a Nevada LLC owning property in Nevada, would nonetheless be subject to the annual LLC franchise tax because he could (from California) (1) hire and fire the Nevada management company, (2) have telephone conversations from California with the management company, and (3) was ultimately responsible for and oversees the management company from California.   The FTB need not consider the frequency or continuity of the California activities as a single activity tied to California could be sufficient to impose the Franchise Tax. This was considered by many experts to be an aggressive stance to tax out of state corporations and LLCs that had any connection with California.

In July 2014, the Franchise Tax Board doubled down on this policy and issued its Legal Ruling 2014-01 that if an LLC doing business in California was classified as a partnership for tax purposes, ALL of its members were also deemed to be doing business in California even if the individual LLC member never stepped foot into California or performed any transactions in California.  The rationale was that in an LLC taxed as a general partnership, each partner has the right to participate in the management of the partnership business, and it made no difference if the partner/member never actually participated in the management of the business.  In a general partnership, all partnership’s activities are attributable to each partner, and so if the partnership were doing business in California, then all the partners were also doing business in California.  Contrast that with the situation of a limited partner which the California Board of Equalization recognized in a 1996 decision of Amman & Schmid Finanz AG, did not have the right to manage or conduct the business of the limited partnership, and therefore, would not be considered doing business in California merely because of its limited partner interest in a California Limited Partnership.

The Swart Enterprises case was the test case for an out of state entity whose only connection to California was a passive investment in an LLC that happened to be taxed like a partnership.  Legal Ruling 2014-1 made clear that if an LLC doing business in California was owned in part by a corporation that had no independent presence or activities in California, the corporation would still need to register and pay the minimum annual $800 franchise tax fee (Situation 4 in Legal Ruling 2014-1).   Swart Enterprises was an Iowa corporation operating a farm in Kansas who had no physical connection to California except that it invested $50,000 for a .2% interest in Cypress LLC which was a California LLC.  Swart had no involvement in any of Cypress’ operations or management, and the Cypress LLC documents specified that the Cypress LLC was “manager managed,” and that no member could take part in the control, conduct or operation of the business, or bind the LLC or act on its behalf unless it was the “manager.”   Despite the fact that Swart had no independent business activities in California, the FTB concluded that that Swart owed the $800 minimum tax because the Cypress LLC elected to be taxed as a partnership, and all of its members would be considered doing business in California if the LLC itself was doing business in California.  In other words, the FTB applied its rationale in Situation 4 of Legal Ruling 2014-1 to conclude that Swart owed the $800 minimum franchise tax in California.

The Court of Appeals rejected the conclusion of the FTB and, focusing on the language in § 23101 requiring “actively engaging” in a transaction in California and following the rationale in Amman & Schmid, concluded that Swart’s purely passive investment did not meet the standard for doing business in California.  The Court concluded that an LLC electing to be taxed as a partnership does not make each LLC member a “general partner” for purposes of the franchise tax.  Among the other factors considered by the Court in favor of Swart included the following:

  1. Swart had no interest in any of the specific assets of Cypress LLC;
  2. Swart had no right to act, bind, or be liable for the obligations of the LLC, was specifically prohibited from management and control of the LLC which was reserved only for managers, and these limitations were specifically referenced in the LLC’s Articles and/or Operating Agreement;
  3. Cypress LLC was a “manager-managed” LLC, and under California law, a member who is not a manager in a “manager-managed” LLC has no authority to manage or conduct LLC activities; and
  4. There was no evidence that Swart actually conducted any management activities for the LLC.

Because Swart was deemed to be the “quintessential passive investor” akin to a limited partner who never performed any activities in California, the mere fact it was a member of an LLC in California did not result in imposition of California Franchise Taxes.

This case is most relevant for out of state entities seeking to invest in California.  Unfortunately, it does not provide any real assistance for California residents seeking to invest in entities outside of California.  Appellate decisions typically go to great lengths to limit the impact of rulings only to the specific facts of the case, and therefore, it is unknown if the outcome would be different if any of the factors 1-4 listed above were different.   In the opinion of this author reviewing the Court’s analysis in Swart, if the Court were presented with a situation similar to Paul from FTB Publication 689, the Court would likely agree with the Franchise Tax Board that Paul was “actively engaged in transactions” in California, and therefore, owes the minimum $800 Franchise Tax.  Nevertheless, Swart should settle the issue that merely passively investing in an entity in California will not, by itself, constitute “doing business in California.”

Hulk Hogan & Asset Protection Lessons from Bollea v. Clem

December 6, 2016 Asset Protection, Business planning Comments Off on Hulk Hogan & Asset Protection Lessons from Bollea v. Clem

In one of the more highly publicized cases of this year, in March 2016, a Florida jury in the case  Bollea v. Clem  awarded Hulk Hogan $115 Million in compensatory damages and $25M in punitive damages against the owners and operators of the Gawker website.  Gawker was a website founded by Nicholas Denton devoted to media news and gossip.   In the lawsuit, Gawker was accused of violating Hulk Hogan’s privacy by posting private videos of Hogan engaged in sex acts.

Several months after this jury award, both the LLC and corporation which allegedly ran the Gawker website, along with Nicholas Denton filed for bankruptcy.  The Gawker website which reportedly had over 23 million visitors per month in 2015 was permanently shut down in August 2016.   A review of the case along with Gawker’s structure as revealed in the bankruptcy documents illustrates some important asset protection principles to remember.

  1. Keep your Asset and Businesses Separate. In general, our approach to asset protection involves separating your assets from your business so that if your business gets hit with a big lawsuit, your assets are less likely to be at risk because they are held in entities separate from the business.   In this case, the Gawker website was operated by Gawker Media LLC.  Bankruptcy documents show that Gawker Media LLC was in turned owned 100% by Gawker Media Group, Inc.  Nicholas Denton owned approximately 30% of the shares of Gawker Media Group, Inc.   Certainly there could be other practical benefits from this hierarchical parent/subsidiary structure, but one of the risks of having everything owned in this linear structure is the possibility that a significant liability could cause the entire house of cards to fall.     Moreover, bankruptcy documents further show that the operator of the website, Gawker Media, LLC also owned substantial interests in real estate and intellectual property, all of which would be exposed to a significant liability from the website activities.   If you are running a website that posts negative information about rich and famous, does it make sense to also own valuable real estate and other assets in the same entity?  In the case of Gawker Media, LLC,  it also owned other websites and branding which were eventually sold to Univision through the bankruptcy process, but whenever you own significant assets, you should consider whether to segregate these assets into different entities to spread out the risk so that a liability coming from one direction does not infect the entire pool.
  1. Entities are not a License to Engage in Misconduct. One of the main reasons for using an entity like a corporation or LLC is to take advantage of the “corporate veil” which generally protects the owners from being personally responsible for debts incurred by the entity.  However, the corporate veil is not absolute.   In the Gawker case, despite the existence of a multi-entity structure, the jury specifically found that Nicholas Denton personally participated in the posting of the explicit videos that resulted in the lawsuit, in addition to allegations that he personally edited the video that ultimately appeared on the site, which contributed to a finding of personal liability.   Courts will generally disregard or “pierce the corporate veil” if the owners are using the entity to perpetrate fraud or engage in other wrongdoing, and so don’t think that the corporate veil will be there to protect you if you are committing fraud or other intentional misconduct.
  1. There is no 100% Guaranteed Asset Protection Strategy, but the Goal Should be a Multiple Barrier Approach.  As further discussed in Mark Kohler’s book “Lawyers are Liars,” there is no 100% guaranteed approach to asset protection.  Instead, the goals should be to implement as many barriers as you are willing to utilize depending on the cost, complexity and degree of protection afforded by the strategy.  Whether it is having the right insurance, ensuring your contracts are sound, stripping your assets of equity available to creditors, or multiple LLCs, the goal is to implement as many strategies as you can to make it as hard as possible for a creditor who would pursue you.

The Gawker case is a good illustration of the possibility that any asset protection strategy could be toppled if you have a motivated, resourceful litigant.   It was no secret that Hulk Hogan’s lawsuit is and was assisted by financing from billionaire venture capitalist Peter Thiel, who was also a previous target of Gawker’s posts, and was therefore motivated to financially assist Hulk Hogan and other litigants suing Gawker.  Denton has reportedly admitted that Thiel’s campaign against Gawker Media made the Gawker.com website too risky for Univision to purchase, and as a result, the website that had previously drawn the ire of Peter Thiel had to be shut down.

The outcome of litigation is often impacted by the financial resources of the parties, and having a well-designed multiple barrier asset protection strategy could make other adversaries (Peter Thiel excepted) think twice about how far they are willing to go.

The Gawker case, currently on appeal and in bankruptcy, is still pending and given the unpredictability of litigation, the ultimate outcome has yet to be decided.   Nevertheless, Denton has reportedly admitted that, even if the judgment is reversed on appeal, “Peter Thiel has already achieved many of his objectives.”     Therefore, the case is just another reminder that, regardless of whether you are an entrepreneur/executive worth hundreds of millions of dollars, or simply have a 401K and a rental, we all need to be cognizant of the potential legal consequences of our actions, and have a concrete strategy for protecting the fruits of our labor if and when an unexpected liability arises.

How to Negotiate a Solid Contract

November 15, 2016 Asset Protection, Business planning, Law, Small Business Comments Off on How to Negotiate a Solid Contract

Lets face it, we all have to deal with contracts, many of us on a daily basis, and it is the law of contracts which forms the very foundation for our civil and commercial society.  The main purpose of a contract is to memorialize and confirm the intentions and future performance of the parties to the contract, and our society would be fraught with chaos were it not for laws that bind parties to their contractual agreements.

In our practice, we see a lot of bad deals and lost investments that result from the failure to have the deal memorialized in a solid written agreement, or that the agreement that was signed did not have sufficient provisions to protect the party’s interests.  While it is true that oral agreements can be binding, the problem is how will you prove in court what the terms of the oral agreement were if the other side fails to perform?  If and when a dispute does arise from an oral agreement, be assured that the opposing party will likely have a different version of what was said, or at least their recollection will be foggy.  For that reason, we will always recommend that your deal or understanding should be confirmed in a comprehensive, written agreement.

While no article can address all of the issues that could arise in a given transaction, and certain types of transactions will call for varying type of contractual provisions, here are a few tips to help ensure that your contracts will adequately protect your interests in any given transaction.

  1. Make sure the contract addresses all of your expectations for the transaction. The whole reason for having contracts is to confirm who will do what, when, where, and how.   We have seen our share of overly simplistic agreements that the parties “thought” were adequate, but failed to contain sufficient specificity as to all of the expectations of the parties.  For example, I had a case where the parties signed a written agreement that they would start a business and be 50-50 owners.   Nothing else was mentioned regarding who would do what, who was responsible for what, and what would happen to the business if they split or disagreed.  The subsequent result was years of litigation and tens of thousands of dollars in legal fees even though technically they did have a written contract.   A contract should be very specific and detailed as to each and every expectation you have of the other side.  Anything you expect the other side to do, not do, or any rights, protections or contingencies you want to preserve should be confirmed in detail in the contract.   Don’t assume that if the other side told you something verbally, in an email or text, that it necessary be enforced.  If a particular issue, term, or detail has any importance to you, put it in the final written agreement.
  2. Make sure terms are objectively clear and comprehensive.  Terms in a contract should be objectively clear and understandable.  I often see agreements that contain references that would only be understood by those in the industry, or worse, only by those individuals who were parties to the agreement.  Keep in mind that if the other party defaults and you need to have the agreement enforced, it will likely be a lawyer, judge, or jury that decides your case.  Therefore, the terms in your contract should be written as if it were to be interpreted by someone who has no experience or knowledge with your particular transaction, since realistically they will likely be the ones to interpret or enforce the agreement in court.    Many contracts written by attorneys will begin with a summary of the facts and circumstances giving rise to the agreement itself which helps provide context to third parties for the provisions that follow.
  3. Make sure you properly address foreseeable contingencies or breakdowns. Similar to No. 1, many laypersons inexperienced in negotiating agreements frequently fail to consider all the possible ways their agreement could fail.  One of the most important aspects of a solid contract is to fully address all the “what ifs” in a given transaction.  Indeed one of the best ways to protect your rights in a transaction is to fully address each and every way the transaction could go wrong (i.e. events of breach or default), and what will be the rights of the parties if or when those events occur (i.e. remedies or enforcement upon default).  Some may feel they are disrespecting or offending the other side by bringing up these concerns, but the best time to address these types of issues is BEFORE they occur.    Similarly, many inexperienced with contracts or the process that is involved to enforce a contract in court fail to even consider the possibility that a dispute could arise, and that they may end up having to pay attorneys’ and other fees to enforce their rights.  The general rule in America is that unless you specifically provide for attorney’s fees in the contract, each party will pay their own attorney’s fees if court intervention becomes necessary.  Therefore, I generally recommend dispute resolution provisions and attorney’s fees clauses in every contract.

These tips are not intended to be a substitute for consulting with your attorney or other professionals who have experience in your particular type of transactions, and can advise you on terms and issues that could likely arise that should be included in the contract.   Given the proliferation of contracts in today’s society, it would be unrealistic to expect that you would apply this level of scrutiny to every contract you see.  However, if you have important rights at stake in a given transaction, these tips along with consulting your attorney will help ensure that, for THIS contract, your interests are adequately protected in the deal.