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Illinois LLCs – The Asset Protection Advantage

Illinois LLCs – The Asset Protection Advantage

A Technical Analysis

Among sophisticated investors and other high-asset/high-net worth individuals and businesses, the topic of “asset protection” is bound to arise. As many became painfully aware during the recent Great Recession, bad things can happen to good people. In my article Asset Protection – Lessons Learned, I discussed how properly structuring one’s holdings could have prevented, or at least mitigated, much of the financial devastation and anguish experienced by business owners, investors, real estate developers, doctors and others caught off-guard by the drastic economic collapse of 2007-2010.

RSP_LogoFull_2PMSOften, there is confusion about what the term asset protection really means. Some imagine a shadowy network of off-shore trusts and secret bank accounts in foreign lands set up by unscrupulous characters to cheat innocent creditors. This is simply not true. In this article I will not debate the claimed pros and cons of secret bank accounts and so-called off-shore asset protection trusts. I will say, however, that under most circumstances, they don’t work for U.S. citizens residing in the U.S.A.

Legitimate asset protection is nothing more or less than properly ordering one’s business and financial affairs in a way that does not unnecessarily expose all assets to claims of creditors.

The right of persons and businesses to limit their liability and exposure of their assets to claims of creditors is the well settled in the U.S.A. The United States of America, and each individual state, has a plethora of laws authorizing and recognizing the legitimacy of corporations and other limited liability entities as a means by which an investor can segregate assets and limit exposure to liability.

No person has a legal or moral obligation to structure his or her affairs in a way that makes it easy for a creditor of one business or professional enterprise to attach assets of the investor not committed to that enterprise. This protection may be impinged if the person or business engages in conduct tantamount to fraud, but actions explicitly authorized by applicable statute can hardly be characterized as being fraudulent. Fraud is an intentional tort requiring, among other elements, intentional breach of a duty owed to the person claimed to be harmed. If a statute expressly authorizes conduct, it implicitly, if not explicitly, negates any duty to act in a manner contrary to that authorized by the statute.

This article presents a technical analysis of certain asset protection attributes of an Illinois limited liability company expressly authorized by the Illinois Limited Liability Company Act, 805 ILCS 180/1-1 et seq (the “Illinois LLC Act”). The remarkably robust asset protection value of an Illinois limited liability company is measured by two key attributes:

1. The ability, expressly authorized by the Illinois LLC Act, to include in an LLC operating agreement provisions that protect the limited liability company and its business and assets from claims owed to others by members of the LLC – an attribute that creates a huge advantage vs. a corporation, as discussed in Part I, below; and

2. Enhanced protection of Members and Managers from liability for debts, contracts and torts incurred by the LLC, or resulting from acts or omissions of a Member or Manager while acting on behalf of the LLC, to an extent measurably greater than the protection afforded officers, directors and shareholders of a corporation.

Although one might reasonably expect that the order in which these key attributes are discussed would be reversed, the Part I discussion precedes the Part II discussion because the matters to be discussed in Part I are best considered at the outset, when the operating agreement is being drafted; while the matters discussed in Part II will most directly apply later, once a judgment creditor is seeking to enforce its judgment.

PART I: Key Statutory Provisions to Consider When Drafting the Operating Agreement

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POP QUIZ! — Commercial Real Estate Due Diligence

I read once that if you took all the lawyers in the world and laid them end to end along the equator — it would be a good idea to leave them there.

That’s what I read. What do you suppose that means?

RSPI have written before about the need to exercise due diligence when purchasing commercial real estate. The need to investigate, before Closing, every significant aspect of the property you are acquiring. The importance of evaluating each commercial real estate transaction with a mindset that once the Closing occurs, there is no going back. The Seller has your money and is gone. If post-Closing problems arise, Seller’s contract representations and warranties will, at best, mean expensive litigation. CAVEAT EMPTOR! [“Let the buyer beware!”]

Paying extra attention at the beginning of a commercial real estate transaction to “get it right” can save tens of thousands of dollars versus when a deal goes bad. It’s like the old Fram® oil filter slogan during the 1970’s: “You can pay me now – or pay me later”. In commercial real estate, however, “later” may be too late.

Buying commercial real estate is NOT like buying a home. It is not. It is not. It is NOT.
In Illinois, and many other states, virtually every residential real estate closing requires a lawyer for the buyer and a lawyer for the seller. This is probably smart. It is good consumer protection.

The “problem” this causes, however, is that every lawyer handling residential real estate transactions considers himself or herself a “real estate lawyer”, capable of handling any real estate transaction that may arise.

We learned in law school that there are only two kinds of property: real estate and personal property. Therefore – we intuit – if we are competent to handle a residential real estate closing, we must be competent to handle a commercial real estate closing. They are each “real estate”, right?

ANSWER: Yes, they are each real estate. No, they are not the same.

The legal issues and risks in a commercial real estate transaction are remarkably different from the legal issues and risks in a residential real estate transaction. Most are not even remotely similar. Attorneys concentrating their practice handling residential real estate closings do not face the same issues as attorneys concentrating their practice in commercial real estate.

It is a matter of experience. You either know the issues and risks inherent in commercial real estate transactions – and know how to deal with them – or you don’t.

A key point to remember is that the myriad consumer protection laws that protect residential home buyers have no application to – and provide no protection for – buyers of commercial real estate.

Competent commercial real estate practice requires focused and concentrated investigation of all issues material to the transaction by someone who knows what they are looking for. In short, it requires the experienced exercise of due diligence.

I admit – the exercise of due diligence is not cheap, but the failure to exercise due diligence can create a financial disaster for the commercial real estate investor. Don’t be “penny wise and pound foolish”. If you are buying a home, hire an attorney who regularly represents home buyers. If you are buying commercial real estate, hire an attorney who regularly represents commercial real estate buyers.

Years ago I stopped handling residential real estate transactions. As an active commercial real estate attorney, even I hire residential real estate counsel for my own home purchases. I do that because residential real estate practice is fundamentally different from commercial real estate.

Maybe I do harp on the need for competent counsel experienced in commercial real estate transactions. I genuinely believe it. I believe it is essential. I believe if you are going to invest in commercial real estate, you must apply your critical thinking skills and be smart.

POP QUIZ:

Here’s a simple test of YOUR critical thinking skills:

Please read the following Scenarios and answer the questions TRUE or FALSE: (more…)

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STRATEGIES FOR ASSESSING COMMERCIAL TENANT CREDIT

David Resnick, Attorney Robbins, Salomon & Patt, Ltd.

David Resnick, Attorney
Robbins, Salomon & Patt, Ltd.

GUEST BLOG BY DAVID RESNICK of ROBBINS, SALOMON & PATT, LTD.

When considering a lease, tenants are usually focused on the location, size and quality of the leased space, and perform some minimal diligence on the landlord and property manager to ensure fair treatment over the course of the term. Landlords have a more difficult task,however. A prospective tenant, and most importantly, that tenant’s ability to pay rent, is often unknown to the landlord. In recent years, real estate professionals have witnessed expansion in the array of users of commercial space and at the same time, property owners have been compelled to seek out new types of tenants. Increasing numbers of start-ups and new ventures are seeking to lease space, many of which are backed by various types of equity financing. As a result of these changes, landlords should be particularly vigilant in understanding how their tenants make money, as well as the financial identities of the parties backstopping the obligations of those tenants.

Analyze Tenant Credit

Landlords should always analyze tenant credit in the context of the lease. After all, the success of leased real estate, as well as the property owner’s ability to borrow against that asset, is dependent upon the stability of its tenants. While rent is the primary economic factor in any lease transaction, other factors such as term (including rights of extension), area of the premises (including rights of expansion and rights of first refusal on additional space) and the scope of tenant improvements create the platform upon which a tenant’s credit can be evaluated. For example, substantial build-out (regardless of who pays for it) that may inhibit the re-letting the space following a default. Therefore, landlords should be mindful of the tenant’s capacity to pay its construction obligations, which capacity is usually encapsulated in the tenant’s credit and litigation history.

A proper underwriting of a tenant’s credit requires a thorough understanding of that tenant’s business. A prudent landlord will pay attention not only to the tenant’s sources of revenue, but to the market upon which the tenant relies and the business plan upon which the tenant charts its future success. What are the contours of the business model? Is the revenue sustainable? What is the plan for future growth? Has the tenant gone through restructuring or been forced to lay off personnel? Landlords can avoid doing business with troubled or unstable tenants by performing background, lien and litigation searches on the tenant parties as part of the underwriting process. This kind of diligence can usually be completed in a short time-frame at a reasonable cost, and may save substantial time and money if the landlord is forced to evict a tenant it should have known to be at increased risk of default.

Technology has given rise to new products which enhance the process of underwriting tenant credit. For example, the Chicago firm (RE)Meter has created the first “credit score” for commercial tenants, which captures and synthesizes proposed lease transaction terms and basic tenant financial information with exclusive data maintained by a number of federal agencies, including the U.S. Census Bureau, the Department of Labor and the Internal Revenue Service ((RE)Meter is the first firm to access IRS information in this context). The end product, called the TIL Report, can be completed in a mere 15 minutes and offers landlords a sector- and market-specific analysis of its prospective tenants, reflecting a number of detailed metrics including growth trends, profitability and rent per employee. Innovations like these have altered the landscape of tenant underwriting and will enable landlords to make more prudent decisions when marketing space and assessing the risk of potential tenants.

Tenant Credit Enhancements

Conventionally, several mechanisms exist to enhance the credit of a prospective tenant who fails on its own to meet the underwriting criteria of the landlord. The first and foremost of these is the security deposit, which is posted by the tenant in the form of cash or letter of credit and held by the landlord for all or part of the duration of the lease. The deposit may be applied by the landlord towards unpaid amounts payable under the lease like rent, proportionate common area expenses or taxes, or reimbursement of amounts expended to repair damage to the premises. A stronger credit tenant may receive the benefit of a return of all or part of the deposit held by landlord over time, provided the tenant has not defaulted.

Security Deposits

While cash security deposits have historically been the industry standard in commercial leasing, landlords are increasingly requiring letter of credit security deposits instead. For many landlords, the benefits of cash on hand are overshadowed by the security of an obligation issued by a third-party bank, particularly when the landlord is able to draw on the letter of credit following a default without notice to or consent by the tenant. Letters of credit also may bear advantages to the landlord following a bankruptcy by the tenant, as the obligation of the issuing bank to pay on the letter of credit is independent of the tenant’s obligations under the lease. However, some courts have found that letter of credit security deposits are part of the tenant’s bankruptcy estate and thus subject to the cap on a landlord’s claim for damages under Section 502(b)(6) of the United States Bankruptcy Code.

Lease Guaranties

Guaranties are a common alternative for securing the credit of a commercial tenant. In the context of commercial leasing, a guaranty is a legally enforceable undertaking by a third party to fulfill the payment or performance obligations of the tenant under a lease. A guaranty may be given by an entity, such as a corporate parent or affiliate, or an individual, such as a majority owner or other key principal of the tenant. To most effectively backstop the credit of the tenant, a guaranty should be a guaranty of payment as opposed to a guaranty of performance. This distinction ensures that the landlord will not be forced to exhaust its remedies against the tenant before pursuing enforcement of the guaranty. Rather, the landlord may pursue the tenant and guarantor simultaneously for unpaid amounts under the lease.

Once a landlord has determined that it will require a guaranty to secure the tenant’s obligations under the lease, what should the landlord look for in evaluating potential guarantors? The most straightforward factor, notwithstanding whether the proposed guarantor is an individual or an entity, is cash on hand and other liquid assets. In satisfaction of the landlord’s inquiry, an guarantors may produce income tax returns, bank statements, financial statements, balance sheets or other evidence of personal holdings. The review process for publicly traded companies is simplified in that pertinent financial information is publicly available. Of course, testing for liquidity has its flaws. There exists no iron-clad protection against fraud, and disclosures only present a snapshot of a party’s credit at the time of the test as opposed to a forecast of future liquidity and stability. A review of tenant and guarantor financial information, as well as credit reports for collections, pledging of material assets or opening of new lines of credit, should be performed at regular intervals throughout the term of the lease.

Financial Disclosure Challenges

Financial disclosures may be problematic or some privately-held concerns. Particularly in the modern era of start-up firms financed by venture capital and private equity interests, tenants and proposed guarantors may be limited by investor confidentiality. With this in mind, parties to a lease should clarify in the lease or guaranty the form of any future disclosures to be made. Tenants and guarantors may resist delivering full-fledged audited financial statements in favor of reduced balance sheets or nominal form of profit and loss statement. Depending on the profile of the market and building, landlords may be willing to accept less than full disclosure if the statements deliver a reasonable picture of the financial health of the party delivering them.

Tenant Stability and Performance Incentives

As lease term and the disclosure provisions are negotiated, tenants may push the landlord for a variety of concessions that effectively incentivize and reward tenant stability. Perhaps the most common examples of this request are limitations on the security deposit, pledged assets or the liability under or the term of the guaranty. Limitations like these can take a variety of forms, from a fixed term to a cap on the guarantor’s liability based upon a fixed dollar-figure or factor of rent payable under the lease, to an automatic reduction of either the security deposit or the cap on the guarantor’s liability over time. In each instance, the landlord should be cognizant of the hurdles the tenant party must overcome to receive the benefit of these limitations, none more important than the uninterrupted timely payment of rent without default.

Tenant Credit is a Key to Successful Lease Performance

In light of the crises our industry has withstood in recent years, a landlord’s exuberance in welcoming new tenants is understandable. But in the current era of increasing economic growth, landlords should adopt a cautious approach in understanding and monitoring the business of their tenants. No landlord can predict with certainty the success or failure of its tenants; however, perhaps now more than ever, a thorough and complete examination of tenant credit is essential to the financial success of any leased real estate.

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THIS WOULD BE A FUN PROJECT TO REDEVELOP: Check out this article

Now, at last, the Old Main Post Office might find a real savior By Joe Cahill : http://www.chicagobusiness.com/article/20141205/BLOGS10/141209834

R. Kymn Harp
ROBBINS, SALOMON & PATT, LTD.
www.rsplaw.com
rkharp@rsplaw.com
www.HARP-OnThis.com
Sent from my iPad

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THE TIC TRAP – SECTION 1031 EXCHANGES – A DANGER ZONE

This is the third and final installment of a three-part series on Section 1031 like-kind exchanges. Part 1 explained WHY you should consider use of a Section 1031 like-kind exchange when selling commercial or investment real property. Part 2 covered the key rules for HOW to implement a Section 1031 like-kind exchange. This Part 3 covers special issues applicable to a Section 1031 like-kind exchange when a Tenant-In-Common [TIC] interest is being acquired.

THE TIC TRAP

A Section 1031 Exchange Danger Zone

All property lawyers learned in law school that interests in real property can be held in a variety of ways. Common ways to hold title include: as a sole owner, as joint tenants with right of survivorship, as tenants by the entirety, and as tenants in common, among others.

Black’s Law Dictionary defines tenancy in common as: A form of ownership whereby each tenant (i.e. owner) holds an undivided interest in property. Unlike a joint tenancy or a tenancy by the entirety, the interest of a tenant in common does not terminate upon his or her death.

RSPA tenancy in common [often referred to as a “TIC Interest”] is well recognized by property lawyers as a real property interest.

Naturally, then, for investors involved in Section 1031 exchanges, the question will arise as to whether a taxpayer can acquire a TIC Interest as a replacement property in a Section 1031 exchange. On its face, the flexibility this would allow, if permitted, would appear to be exceptional.

Consider a taxpayer who (more…)

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Value Investing vs. Momentum Investing

As the commercial real estate market begins to pick up steam, beware the urge to follow a “momentum” investment strategy rather that a “value” investment strategy.

http://www.dreamstime.com/royalty-free-stock-photography-skeleton-keys-image28661257Momentum investing relies on market increases to generate a return on investment. It is the “rising tide floats all boats” investment model. It is the investment model of which all “bubbles” are made.

As momentum investing accelerates, investment fundamentals tend to get lost. Instead of evaluating cash on cash returns using discounted cash flows that underlie “value” investing, a casino mentality takes hold – whereby investors can justify acquiring assets generating even a negative cash return, with the notion that rising prices will yield a profit. As the saying goes: “Any fool can make a profit in a rising market – and many fools do”. The challenge, of course, comes when a market hits a plateau or, worse yet, the market declines.

As a general proposition, value investing is significantly more prudent. If a project is cash flowing, and generating a positive return on investment, today and for the foreseeable future – which is a fundamental precept of a value investment strategy – the potential added return of any increase in value in the underlying asset caused by the “rising tide” effect is icing on the cake. Choose your cake with care.

There are, of course, exceptions to every rule. But, employing an “exception” is wisely done only after sober reflection of the particular circumstance to determine that in that particular case the exception is warranted. When an exception is regularly employed, it is no longer an exception – but, rather, becomes the rule itself.

As in all markets, there will be winners and there will be losers. It makes sense in the coming commercial real estate revival to position yourself and your company as a winner. You may not get another chance.

Exercise all appropriate due diligence. Use readily available and appropriate asset protection strategies. Invest with intentional regard to reliably building wealth though a well conceived value investing strategy – not a roulette table strategy that, over time, is virtually certain to fail.

If this recent economic debacle has taught us anything, it has taught that bad things can happen to good people who lose sight of the fundamentals. Good deals – even great deals – can be made if reliable commercial real estate investment fundamentals are employed.

As a wise mentor once told me: “You have a good brain – use it.”

Good luck.

R. Kymn Harp
Robbins, Salomon & Patt, Ltd.
Chicago, IL
www.rsplaw.com
JOIN MY THOUGHTBOARD: www.Harp-OnThis.com

REPORTING FROM THE FIELD. . .

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Keys to Closing A Commercial Real Estate Transaction

http://www.dreamstime.com/royalty-free-stock-photography-skeleton-keys-image28661257Commercial Real Estate Closings

Anyone who thinks closing a commercial real estate transaction is a clean, easy, stress-free undertaking has never closed a commercial real estate transaction. Expect the unexpected, and be prepared to deal with it.

I may not charm your socks off with industry gossip, sports-talk or movie quotes, but give me a complex commercial real estate deal to close and I’ll get it done.

I’ve been closing commercial real estate transactions for over 35 years. I grew up in the commercial real estate business.

My father was a “land guy”. He assembled land, put in infrastructure and sold it for a profit. His mantra: “Buy by the acre, sell by the square foot.”  From an early age, he drilled into my head the need to “be a deal maker; not a deal breaker.” This was always coupled with the admonition: “If the deal doesn’t close, no one is happy.” His theory was that attorneys sometimes “kill tough deals” simply because they don’t want to be blamed if something goes wrong.

A key point to understand is that commercial real estate Closings do not “just happen”; they are made to happen. There is a time-proven method for successfully Closing commercial real estate transactions. That method requires adherence to the four KEYS TO CLOSING outlined below: (more…)

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Raising Capital for Real Estate Investment

At long last, the real estate investment market is beginning to show signs life. Commercial and industrial property transactions are increasingly common, and multifamily properties of all sizes are being snapped up by investors. Historically low interest rates, high occupancy rates, increasing rental rates, and rising property values are contributing factors.

RSPEarly transactions have often been cash deals, where the investor paid cash for the property rather than seek financing. This can be a great opportunity to achieve high yields for investors flush with cash, but what about everyone else?   What about potential investors who have limited cash on hand?

Unlike the easy-credit days preceding the Great Recession, real estate investment financing is (more…)

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Asset Protection – Lessons Learned

“The best time to plant a tree was twenty years ago.

        The second best time is today.”

Chinese proverb

http://www.dreamstime.com/stock-image-empty-safe-image27096841For over 35 years, I have represented commercial real estate investors, developers and business owners. Most of that time has been spent helping them acquire, finance, expand, develop, manage and grow their assets and businesses. For the past 5 to 6 years, as we have struggled through the Great Recession, a huge amount of my time has been spent helping clients keep their assets.

Growing up, I was steeped in the practical view that it is not so much what you acquire that counts, but, rather, what you keep. My parents and grandparents were not in the real estate business to make others wealthy. They were playing real life Monopoly®. They played to win. It was less about money for money’s sake than it was (more…)

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LENDING BLIND – SIX YEARS AFTER LEHMAN’S COLLAPSE

Commercial Real Estate Lending:  What You Don’t Know Can Hurt You!

If there is anything commercial real estate lenders have learned during the collapse of the commercial real estate market over the past five or so years, it would be the danger of “lending blind”.  Commercial real estate lending without fully understanding the project is a prescription for disaster. An original version of this article was first published in 2005.  It is eerie how prophetic the warning signs were. Surely lenders have learned. . . . (more…)

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