MONDAY, OCTOBER 5, 2009
Federal Trade Commission Issues Tough New Rules for Bloggers and Social Media Endorsements
For the last year or so, I've been warning my clients that the Federal Trade Commission is becoming more involved in regulating online commerce, specifically in terms of disclosures relating to online content. In particular, I've been telling companies that the FTC is likely to implement new guidelines that will bring blogs, Internet forums, message boards, word-of-mouth marketing, social media marketing, social commerce, and other forms of electronic and viral marketing in line with fair advertising practices that have not been updated in more than 25 years.
Well, earlier today, in a highly anticipated move, the FTC did just that. By a vote of 4-0, the Commission has approved new rules requiring bloggers and social media users to disclose payments they receive from companies for reviewing their products. The rules, which go into effect Dec. 1, give clear guidance to advertisers on how to keep their endorsement and testimonial ads in line with the FTC Act (warning: link takes you to a pdf file, not a Web page).
Under the revised rules, advertisements that feature a consumer and convey his or her experience with a product or service as "typical" when that is clearly not the case, will be required to disclose the results that consumers can generally expect. In contrast to the 1980 version of these same rules--which allowed advertisers to describe unusual results in a testimonial, as long as they included a disclaimer such as "results not typical"--the revised rules no longer contain a safe harbor around that issue.
The revised rules also add new examples to illustrate the long standing principle that "material connections" (i.e., payments or free products) between advertisers and endorsers (i.e., bloggers and other online influencers lurking in social media channels like Facebook, Twitter, MySpace, etc.) must be disclosed. These examples address what constitutes an endorsement when the message is conveyed by bloggers or other "word-of-mouth" marketers. The revised rules specify that while decisions will be reached on a case-by-case basis, the post of a blogger who receives cash or in-kind payment to review a product is considered an endorsement. So, bloggers who make an endorsement must disclose the material connections they share with the seller of the product or service, or face a stiff fine from the FTC (which may be as much as $11,000 per incident).
"Companies that sponsor blogs or pay bloggers to cover events -- an emerging trend in branded entertainment -- could face increased legal risk when held accountable for the statements of their bloggers," says Anthony DiResta, general counsel for the Word of Mouth Marketing Association. "A compliance program for brands that outlines policies and practices for selecting, hiring, and monitoring of agents or representatives is essential."
Celebrity endorsers also are addressed in the revised rules. While the 1980 version of the rules did not explicitly state that endorsers--as well as advertisers--could be liable under the FTC Act for statements they make in an endorsement, the revised rules reflect FTC case law and clearly state that both advertisers and endorsers may be liable for false or unsubstantiated claims made in an endorsement--or for failure to disclose material connections between the advertiser and endorsers.
The revised rules also make it clear that celebrities have a duty to disclose their relationships with advertisers when making endorsements outside the context of traditional ads, such as on talk shows or in social media. By operating with integrity, your company builds a loyal and trusting community and avoids the negative press and legal issues that could result from any failure to disclose word-of-mouth advertising that has been bought and paid for. And, by keeping your social media real, you can generate positive word-of-mouth without having to sponsor or pay reviewers and risking a possible penalty or lawsuit.
Posted by Entrepreneur.com
WEDNESDAY, SEPTEMBER 30, 2009
Sometimes it Takes a Village to Fund a Company - Entrepreneurs Get Creative with Sourcing Funds
Plenty of entrepreneurs are turning to their communities for support in these tricky times. As the recession wreaks havoc on America's economy, finding the money to launch, expand or even just sustain a small business is often a struggle. In the second quarter of 2009, venture capital funds raised the smallest amount since the third quarter of 2003, according to the National Venture Capital Association in Arlington, Va. Banks continue to pull credit lines and credit cards from many small businesses. Even proprietors who are willing to extract capital from their homes -- often their biggest personal asset - can't always do so, because the declining housing market has left so many homeowners underwater.
But entrepreneurs are resourceful, and as the economic crisis forces them to seek new sources of capital, a growing number appear to be finding money in their own backyards. After all, local customers have a personal incentive to invest in their favorite businesses. And while no one is officially tracking the trend, anecdotal evidence suggests that the practice is growing.
John Halko was halfway through renovating an expanded space for Comfort, his mostly organic eatery in Hastings-on-Hudson, N.Y., when the credit crisis hit. His source of funding -- a home-equity line -- ran out, so he applied for a loan at a local bank. He was turned down. Halko wasn't ready to throw in the dish towel. His solution? The modern equivalent of an old-fashioned barn raising. Instead of soliciting neighbors to lift timbers, he asked them to open their wallets. For every $500 they purchased in "Comfort Dollars," his patrons received a $600 credit toward meals at the restaurant. As the community rallied around Comfort, Halko says, "it gave us hope." He raised $25,000 in six months, and the new, larger space - now called Comfort Lounge -- opened for business in May.
Visit http://money.cnn.com/2009/09/08/smallbusiness/barnraising_a_business.fsb/index.htm?section=money_smbusiness for the remainder of the article.
POSTED BY P. J. JAVAHERI, ESQ. AT 4:22 PM
TUESDAY, SEPTEMBER 29, 2009
What is your Idea Worth? -- Matchmaking for Companies
A federally funded online service helps small manufacturers find inventors with new technologies - and estimate their worth.
Process Equipment Co. had a fine history of innovation. Founded in 1946 by Emmert Studebaker, a member of the famous car-making family, PECo sold laser welders and other specialized equipment to GM and other manufacturers. That brought in dependable revenues of $40 million a year.
But demand for PECo's products dropped as GM declined, and last year the Tipp City, Ohio-based firm was forced to lay off a third of its employees. More cuts would come unless PECo could figure out how to adapt its machines to other industries.
Hiring a research firm to do the job would cost $100,000 -- way out of PECo's price range. Now, for just $2,000, PECo can turn to the USA National Innovation Marketplace. In May the Department of Commerce's Manufacturing Extension Partnership teamed up with entrepreneur Doug Hall to offer the service to small businesses. Hosted at Hall's Web site, Planet Eureka, the marketplace matches inventors with manufacturers.
It's too soon to say whether such matchmaking will work in the small company world. But the National Innovation Marketplace has no shortage of ideas waiting to be picked up. Among them: a food packaging film made from edible soy protein, said to help protect ready-to-eat food from dangerous bacteria; a drug designed to prevent and cure osteoporosis in a single dose (the research predicts that commercialization will take up to 10 years); and a "supersaver dream sander" that eliminates dust when sanding drywall.
for the full story.
POSTED BY P. J. JAVAHERI, ESQ. AT 5:29 PM
WEDNESDAY, AUGUST 19, 2009
Wells Fargo Sued Over Home Equity Lines of Credit
Hopefully this will give back some breathing room to some well-deserved entrepreneurs.
NEW YORK (AP) - The banking unit of Wells Fargo & Co. is facing a lawsuit claiming it illegally reduced the size of customers' home equity lines of credit.
The suit, which was filed in Illinois, claims Wells Fargo failed to accurately assess the value of customers' houses before deciding to cut the size of their credit lines. San Francisco-based Wells Fargo is being accused of using unreliable computer models that wrongly valued home prices too low to justify cutting the size of customers' loans.
Home equity lines of credit are similar to credit cards in that a customer has a credit limit and can continue to borrow money until the limit is reached. Once a portion is paid off, it again becomes accessible to borrow. But, home equity lines of credit are backed by a borrower's property, whereas credit cares are unsecured.
Michael Hickman, who filed the lawsuit on behalf of himself and is seeking class action status for it, claims Wells Fargo also did not provide proper notice that the bank was reducing the size of the credit lines.
The bank's notice for reducing the lines also did not specifically provide a new estimated value for the property or the method used to determine the houses value. Hickman's lawsuit said that information was needed so a customer could challenge the change in the credit limit and try and reinstate the previous limit.
Wells Fargo responded in a statement, "we are confident in our fair and responsible lending practices, including how we determine home equity credit limits available to customers depending on the amount of equity in their home. Our controls are based on contractual and regulatory guidelines and include a fair appeals process.
"While we are beginning to review the lawsuit, from what we have read so far, it appears to mischaracterize credit controls designed to sustain homeownership."
Hickman is being represented by KamberEdelson LLC, a Chicago-based law firm, which is also representing clients that have filed similar suits against JPMorgan Chase & Co. and Citigroup Inc.
Nearly all banks have been hit hard by mounting loan losses tied to residential real estate over the past two years. Reducing lines of credit can limit exposure to the struggling sector.
Wells Fargo set aside $5.09 billion to cover loan losses, which includes potential losses on home equity lines of credit, during the second quarter. It set aside $3.01 billion during the same quarter last year.
The bank was one of hundreds of financial firms that received bailout money from the government last fall amid the mushrooming credit crisis. Wells Fargo received $25 billion as part of the Troubled Asset Relief Program, and has yet to repay the loan.
Jay Edelson, a managing partner at KamberEdelson, said systematically cutting home equity lines of credit runs opposite of the goals of the bailout program, which was supposed to improve consumers' access to credit.
Wells Fargo's had average total loans of $833.9 billion during the second quarter, compared with $855.6 billion in the first quarter. When it announced second-quarter earnings last month, Wells Fargo said the decline in total loans was a reflection of actions taken to reduce the size of high-risk loan portfolios and came amid moderating demand for new loans.
However, Wells Fargo did ramp up lending in certain areas. It originated $129 billion in mortgages in the second quarter, compared with $101 billion during the previous quarter.
By STEPHEN BERNARD
POSTED BY P. J. JAVAHERI, ESQ. AT 9:07 PM
MONDAY, AUGUST 3, 2009
ARTICLE: SUGGESTED REVISIONS TO THE AIR STANDARD LEASE FORM
Anyone involved in commercial real estate in California is undoubtedly familiar with the American Industrial Real Estate Association (“AIR”) standard lease forms. The ease and affordability of the AIR lease forms have garnered them immense popularity in California for both landlords and tenants alike. Generally, however, the parties merely fill in and sign the standard form while making little, if any, changes to the language of the lease.
So long as everything runs smoothly, landlords and tenants are perfectly happy with this arrangement. However, those parties that have engaged in lease disputes have quickly realized that the standardized lease form often fails to favorably address many of their specific needs. This is why, prior to using a standard AIR lease form, all parties to a lease should thoughtfully assess their interests and attempt to negotiate appropriate revisions.
Although other articles have offered suggestions regarding items to negotiate in the AIR lease, we have attempted to present our own suggested revisions in a clear and concise format with special attention paid to the individual needs of the landlord and tenant.
PROVISION ONE- COMMENCEMENT DATE:
One of the first potential problem areas in the standard lease form is the “commencement date” section. Specifically, Paragraph 3.3, “Delay in Possession,” states that there is no penalty for the landlord for late delivery of the premises as long as the landlord delivers the premises to the tenant within 60 days from the agreed upon commencement date. The tenant’s only remedy is to terminate the lease within the 60-day period. The section also states that if the premises are not delivered within 120 days of the commencement date, the remedy is automatic termination of the lease.
The commencement date paragraphs can pose many problems for both parties. One problem may occur if a dispute arises about construction delays for tenant improvements to the premises. These problems are intensified if the landlord is responsible for the work because the landlord has complete control of the situation.
One more point of interest is how the commencement date is defined. Many times, it is defined as the time at which the landlord reaches “substantial completion” of the tenant improvements. This simply means that the landlord has finished sufficient work so that the tenant may move in and conduct business.
If you are the Tenant:
The situation is further exacerbated because tenants are often in a precarious situation when moving into new premises. They may be moving out of an old rental on a specific date, or have time sensitive arrangements for purchasing and moving furniture or hiring employees. Because of this vulnerable position, a significant delay can pose huge problems for tenants.
Thus, it is important for the tenant to negotiate the commencement date and 60-day delay provision. The tenant may attempt to negotiate for no delay, however most landlords will insist on some delay, even if less than 60 days. Actively negotiating the 60-day period will encourage the landlord to provide the tenant with timely access because the landlord does not want to spend time and money adapting the premises to the tenant’s requests only to eventually lose the tenant.
The tenant should also attempt to require the landlord to pay the tenant’s damages if the landlord delays delivery of the premises. Such revisions might include the landlord agreeing to pay damages for any holdover rent paid by the tenant as a result of the delay.
When the commencement date is defined as “substantial completion,” the tenant must insist that paragraph 3.3 be modified. Without revision, paragraph 3.3 only gives the tenant the right to terminate if the landlord fails to deliver possession of the premises within 60 days of substantial completion. With no modification to paragraph 3.3, the landlord could indefinitely delay completion of the work without any repercussions because the tenant’s 60-day right to terminate only begins after substantial completion. Thus, the landlord will only violate paragraph 3.3 if the landlord substantially completes the work and then fails to deliver possession. Thus, to protect itself, a tenant should negotiate a fixed date by which the landlord must deliver the premises or give the tenant the right to terminate.
If you are the Landlord:
The commencement date paragraphs may also pose problems for landlords. If the commencement date is based on substantial completion, and the tenant is responsible for completion of the work, the same problems may apply. To avoid this, the landlord might insist on shifting the construction delay risks to the tenant. A landlord could attempt to assign the commencement date to either a fixed date or the date the tenant opens for business, whichever comes first, whether or not the tenant completes the construction. This might prevent the tenant from continually delaying commencement of the lease.
PROVISION TWO - COMPLYING WITH APPLICABLE LAWS:
From a simple reading of the lease, it is often difficult to ascertain which party is responsible for complying with applicable laws (or “requirements”). The lease contains a maze of confusing disclaimers that may or may not be relevant in determining responsibility. Ultimately, the decision of who is responsible for complying with applicable laws may only be determined after examining two cases decided by the California Supreme Court in 1994. These cases, Brown v. Green, 8 Cal. 4th 812 (1994), and Hadian v. Schwartz, 8 Cal. 4th 836 (1994), outline the relevant factors that a court will consider in making such a decision.
In Brown and Hadian, the California Supreme Court held that despite the language in the AIR lease specifically placing the responsibility of complying with applicable laws on the tenant, a landlord may still be responsible for repair costs. In both cases, the court disregarded the clear and unambiguous language in the AIR lease form. Instead, the court applied a six-factor test for the tenant’s obligation to repair. The factors are as follows: 1) the relationship of the cost of the curative action to the rent reserved, 2) the length of the term and the time for the cost to be amortized 3) the relationship of the benefit to the tenant to that of the reversioner (i.e., the landlord), 4) whether the curative action is structural or nonstructural, 5) the degree to which the tenant’s enjoyment of the premises will be interfered with while the curative action is being undertaken, and 6) the likelihood that the parties contemplated the application of particular law or order involved.
The reasoning in Hadian suggests that if the lease is a net lease, then it may be held that the parties intended for the tenant to share in such repair costs. However, neither landlords nor tenants should assume that merely allocating the risk to one party in the lease will control which party will bear the risk. This will only be determined after examining the facts in light of the six-factor test.
If you are the Tenant:
Although the six-factor test is ultimately determinative, the language in the lease may be a relevant factor in determining the outcome. Thus, the parties should make sure the terms of the lease meet their desires and expectations.
A tenant should attempt to revise any language stating that the tenant bear the cost to repair or comply with laws if compliance is mandated after the landlord’s six-month warranty period expires. This is especially true in shorter leases where the majority of the benefit of compliance will go to the landlord. Additionally, a tenant should reject language that gives the landlord the right to terminate the lease if compliance is caused by factors outside the tenant’s use.
The tenant should also protect against language stating that the tenant will lose its lease for something that the landlord will be required to fix even after the tenant leaves. The tenant may want to revise the amortization period to cover the “useful life” of the item rather than the AIR form’s 12-year period. Finally, tenants should try to delete paragraph 49 or at least modify it to state that the landlord must warrant that the premises currently complies with disability laws or will comply by the commencement date.
PROVSION THREE - AUDIT RIGHTS:
Paragraph 4.2 of the AIR office lease form should also be examined closely. This paragraph includes a nonexclusive list of operating expenses that the landlord may charge the tenant and also lays out a few exclusions. Most parties assume that since the list is nonexclusive, further items may be charged to the tenant.
The AIR standard lease does not grant the tenant a right to audit the landlord’s books and records regarding operating expenses. However, while California case law does not give a tenant an implied right to audit, it is generally believed that a tenant may compel an audit during discovery after commencement of a lawsuit.
If you are the Tenant:
Many attorneys for tenants choose to include a list of exclusions from operating expenses in an attempt to clarify what expenses the tenant is paying. The tenant should examine this paragraph closely to make sure that the landlord does not use operating expenses as a source of profit.
If you are the Landlord:
The landlord should make sure that it keeps the inclusions and exclusions consistent in its leases. This way the landlord can avoid accounting confusion from differing leases. The attorney for the landlord should also be aware of any substantive exclusions added to the lease by the tenant that were not part of the original deal.
For Landlords and Tenants:
Because the AIR lease does not grant the tenant a right to audit the landlord’s books, it is beneficial for both the tenant and landlord to include some language about the tenant’s audit rights in the lease. Such additions should include the time and means of requesting and performing the audit, the qualifications of the individual performing the audit, the party that pays for the audit and if the tenant shall be reimbursed for audit costs if there is an error, and issues of confidentiality.
PROVISION FOUR - ASSIGNMENTS AND SUBLETTING:
Assignment and subletting are addressed in paragraph 12, Assignment and Subletting, and paragraph 36, Consent. As is, these sections state that the tenant has the right to assign or sublet to a third party as long as it receives the landlord’s reasonable consent. Although these sections are rather equal, each party may raise certain objections.
If you are the Tenant:
The tenant may notice that the standard lease does not allow the tenant to transfer to an affiliate without the landlord’s consent. If an assignment or sublet results in profits for the tenant, tenants will want to exclude transfer costs such as broker commissions, improvement allowances, downtime, legal fees, etc.
If you are the Landlord:
The landlord may notice that the standard lease does not address recapture rights that give the landlord the right to terminate the lease if the tenant attempts to assign or sublet. However, there is a separate addendum that addresses limited recapture rights. Most landlords will attempt to revise this section to make it unlimited. There is no issue of unreasonableness here, as the California Supreme Court has held that a recapture clause in a commercial lease is enforceable and is not subject to a reasonableness requirement. Carma Developers, Inc. v. Marathon Development California, Inc., 2 Cal. 4th 374 (1992).
If the landlord does not add the recapture addendum, the AIR standard lease will not address situations where the tenant transfers for a profit or how the profit is treated. How profits are split should absolutely be defined by the parties.
The landlord should make sure that the tenant is not attempting to define profit in a manner that avoids paying the landlord its fair share.
The landlord should also address the situation in which the tenant accuses the landlord of improperly withholding consent to a transfer. Paragraph 12.1(e) states that a tenant may recover compensatory damages from the landlord in addition to obtaining injunctive relief. The landlord should include language stating that the tenant must seek a court injunction requiring the landlord to consent rather than sue for damages. Also, the landlord will want to delete the portion of paragraph 12.1(e) regarding compensatory damages.
PROVISION FIVE - SECURITY DEPOSIT: If you are the Landlord:
Paragraph 5 outlines the situations in which the security deposit may be used by the landlord. This section must be revised by the landlord. In 250 L.L.C. v. PhotoPoint Corp., 131 Cal.App.4th 703 (2005), a California court held that under Civil Code §1950.7, the landlord may not retain the security deposit to cover damages for future rent owed under the lease. However, the court did state that in commercial leases, a tenant can waive §1950.7. Such a waiver would allow the landlord to apply the security deposits toward future rent. Thus, the landlord should add an express waiver of §1950.7 or any similar provision of law.
PROVISION SIX - REMOVAL AND SURRENDER:
Paragraph 7.5(b) of the standard form lease states that the landlord may require the tenant to remove alterations and utility installations so long as the landlord gives notice between 30 and 90 days before the end of the lease.
If you are the Tenant:
In response, tenants may want to add language forcing the landlord to give tenants notice of the need for removal of alterations and utility installations before the tenant makes them. The benefit of such language is that, before construction, the tenant can determine the costs of removal at the end of the lease and decide whether the improvements are worthwhile.
PROVISION SEVEN - DAMAGE OR DESTRUCTION: For Landlords and Tenants:
Paragraph 9 of the standard lease gives the landlord the right to terminate the lease if damage costs exceed six months’ rent. This number is not based on any tangible factors and is not traditionally found in other leases. Therefore, depending on the specifics of the lease, the parties may want to alter this section to better suit their specific agreement.
PROVISION EIGHT - LIMITATION OF LIABILITY: If you are the Tenant:
Paragraph 20 states that the tenant must only look to the project for fulfillment of any liability of the landlord regarding the lease. A tenant should attempt to eliminate this provision. However, if the landlord is not willing to delete this language, the tenant and its attorney should attempt to revise the section. The tenant should attempt to include language clarifying that the tenant can also look to the rents, issues, profits, proceeds, and other income from the project regardless if the receiver is the landlord or other. The tenant should also clarify that paragraph 20 has no effect on the tenant’s rights to withhold or offset rents.
PROVISION NINE - NONDISTURBANCE AND ATTORNMENT:
Under paragraph 30.3, the tenant’s subordination of the lease is subject to the receipt of a nondisturbance agreement regarding security devices that the landlord becomes a party to after the lease is executed. The lease however, does not cover security devices that the landlord enters into before the execution of the lease.
Furthermore, paragraph 30.2 of the lease states that a party that takes over the interest of the landlord after a foreclosure will not be liable to the tenant for the previous landlord’s acts or omissions. Additionally, the new landlord will not be subject to any offsets or defenses which the tenant might have against the old landlord. Even though this is a standard provision in most leases, it puts the tenant in a difficult situation if the landlord fails to pay the tenant improvement allowance or construct the tenant improvements.
If you are the Tenant:
The tenant should request that the landlord get a nondisturbance agreement from a lender to protect against termination of the lease upon foreclosure. This may be hard for the landlord to get, but the tenant should request it anyway.
PROVISION TEN - WAIVER OF JURY TRIAL:
Paragraph 47 of the AIR lease requires both the tenant and landlord to waive their rights to a jury trial in any action or proceeding concerning the property or arising out of the lease. This provision may be irrelevant however, because in Grafton Partners LP v. Superior Court, 36 Cal. 4th 944 (2005), the California Supreme Court held that predispute contractual waivers are not enforceable in California.
For Landlords and Tenants:
Because such agreements may not be enforceable in California, a landlord or tenant who wants to avoid a jury trial should include a separate provision in the lease requiring either judicial reference or arbitration.
PROVISION ELEVEN - ELIMINATE BROKER BENEFITS:
One interesting aspect of the AIR standard lease form is the information pertaining to brokers. Because the AIR lease form was drafted and funded by brokers, there is language in the lease that specifically benefits brokers but provides nothing for landlords or tenants. These provisions include Paragraphs 2.4, Acknowledgments; 15.1 – 15.2, Broker Fees; and 25, Disclosures Regarding the Nature of Real Estate Agency Relationship. Most of these provisions have nothing to do with the relationship of the landlord and tenant and should not be included in the lease. Such arrangements should be handled in a separate agreement between the landlord and the broker. Most attorneys will simply advise their clients to erase these provisions. Although the AIR Standard Lease Form is an effective tool in facilitating efficient and straightforward real estate transactions, it often does not adequately address one or both parties’ specific needs. We hope that this article will serve as a valuable asset in assisting both landlords and tenants in negotiating a more appropriate and beneficial use of the AIR Standard Lease Form.
For more information, please contact the author directly at
, or visit the Juris Law Group at www.jurislawgroup.com
The purpose of this article is to assist in dissemination of information that may be helpful to real property investors, and no representation is made about the accuracy of the information. By reading this article, you understand that this information is not provided in the course of an attorney-client relationship and is not intended to constitute legal advice. This publication should not be used as a substitute for competent legal advice from a licensed attorney in your state. IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, any tax information contained in this site was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under federal, state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed on this site.
POSTED BY P. J. JAVAHERI, ESQ. AT 6:12 PM
TUESDAY, JUNE 30, 2009
HOLDING REAL ESTATE IN CALIFORNIA: Benefits of a LLC and a Trust
Owning investment properties can produce big rewards, but also big problems. This is why it is important to hold title to your property in the most beneficial way. A smart investor should consider using both a LLC and a trust to adequately protect himself and his property.
Countless individuals invest in real estate every day. Some dream of becoming the next real estate mogul, while others simply wish to supplement their salary with additional income. Whatever your motivations, owning investment properties can produce big rewards, but also big problems. This is why it is important to hold title to your property in the most beneficial way. The internet is saturated with various posts and articles touting the most effective techniques to manage your property. It can often be a daunting task weeding through the mass of information in an attempt to discern what advice is reliable and what advice can get you into trouble. Our goal here is to provide a succinct and clear summary of the safest and most important strategies for holding investment property in California. We hope the result will be a valuable starting point in considering the best ways to both protect you as the owner/landlord from liability and also guarantee the best treatment of your assets.
The Risks of Owning Real Estate
As stated above, while property can be a valuable investment, there are also significant risks. One of the biggest risks is lawsuits. From common slip and falls, to environmental contamination, landlords and owners are easily exposed to legal judgments. Landlords have also been successfully sued by victims of crimes -- such as robberies, rape, and even murder -- that occur on their property on the theory that the landlord provided inadequate security.
Options for Holding Real Estate
Faced with the risk of lawsuits, it is crucial that you do not own investment real property in your own name. (The only real property you should hold in your own name is your primary residence.) Thankfully, there are several ways in which an individual can hold property other than in his/her own name. These include as a corporation, limited partnership, limited liability company (“LLC”), trust, and many others.
While there are many options, when it comes to real estate investment, LLCs are the preferred entity by most investors, attorneys and accountants.
For many reasons, few investors hold investment real estate in C corporations. A corporation protects the shareholders from personal liability, but the double taxation of dividends and the inability to have "paper losses" from depreciation flow through to owners make a C corporation inappropriate for real estate investments.
In the past, partnerships and limited partnerships were the entities of choice for real estate investors. Limited partners were protected from personal liability while also being able to take passed through tax losses (subject to IRS rules--you'll need an accountant or attorney to sort out the issues of at-risk limitations and so on) from the property. However, the biggest downfall with limited partnerships was that someone had to be the general partner and expose himself to unlimited personal liability.
Many small real estate investors also hold property in a trust. While a living trust is important for protecting the owner’s privacy and provides valuable estate planning treatment, the trust provides nothing in the area of protection from liability. However, although a trust provides no liability protection, it should not be overlooked, as it can easily be paired with an LLC.
Benefits of a LLC
LLCs appear to be the best of all worlds for holding investment real estate. Unlike limited partnerships, LLCs do not require a general partner who is exposed to liability. Instead, all LLC owners -- called members -- have complete limited liability protection. LLCs are also superior to C corporations because LLCs avoid the double taxation of corporations, yet retain complete limited liability for all members. Furthermore, LLC’s are rather cheap and easy to form.
One LLC or Multiple LLCs?
For owners of multiple properties, the question arises whether to hold all properties under one LLC, or to create a new LLC for each additional property. For several reasons, it is generally advisable to have one LLC for each property.First, having a separate LLC own each separate property prevents "spillover" liability from one property to another. Suppose you have two properties worth $500,000 and they're held in the same LLC. If a tenant is injured at property 1, and wins a $750,000 judgment, he will be able to put a lien on both properties for the entire $750,000 even though property 2 had nothing to do with the plaintiff's injury.
On the other hand, if each property had its own LLC, then the creditor could only put a lien on the property where the plaintiff was injured (assuming that they cannot pierce the corporate veil).
Additionally, many banks and lenders require separate LLCs for each property. They want the property they're lending against to be "bankruptcy remote". This means that the lender doesn't want a problem at a separate property to jeopardize their security interest in the property that they're lending on.
Benefits of a Trust
As stated above, an LLC may be used concurrently with a trust to provide the best protection and estate treatment for your property. There are many types of trusts, but the revocable living trust is probably the most common and useful for holding title to real estate. The major benefit from holding property in a trust is that the property avoids probate after your death. As many are aware, probate is a court-supervised process for transferring assets to the beneficiaries listed in one's will. The advantages of avoiding probate are numerous. Distribution of property held in a living trust can be much faster than probate, assets in a living trust can be more easily accessible to the beneficiaries of the trust, and the cost of distributing assets held in a living trust is often less than going through probate. [Note: One should also be aware of other ways to avoid probate. For instance, property held in joint tenancy w/ a right of survivorship automatically avoids probate whether or not the property is in the living trust. Consult an estate planning attorney for more advice regarding probate matters.]
Use Both an LLC and a Trust
Because an LLC and a trust both provide significant benefits to the owner of real property, a smart investor should consider using both a LLC and a trust to adequately protect himself and his property. Utilizing both a trust and a LLC creates the best combination of liability protection and favorable estate planning. To accomplish this, the owner should hold the investment property in a single member LLC, with the living trust as the sole member of the LLC. Here, the trust is the owner of the company and holds all of the interests of the LLC. This form of ownership gives you an added layer of protection from the LLC as well as the additional estate planning benefits of a trust.
For the most part, the costs of forming and maintaining an LLC and trust are rather minimal. For an average LLC, the costs are simply nominal filing fees and an $800 per/yr fee to the state of CA. While simple incorporations may be done on your own, it is strongly advised that you seek the advice of a knowledgeable attorney so that no mistakes are made. The same may be said for forming a trust. A little money now is worth the price of avoiding big problems in the future.
The CA LLC Fee
While the costs of forming a LLC are generally small, there are additional fees that may be imposed on LLCs in California depending on gross profits. The California Revenue and Taxation Code Section 17942(a) includes an additional fee on LLCs if total gross income (i.e. rent) exceeds $250,000. “Total gross income” refers to gross revenues (not profits). Under this Tax Code Section, the amount of the fee is determined as follows:
1. $0 for LLCs with total gross income of less than $250,000;
2. $900 for LLCs with total gross income of at least $250,000 but less than $500,000;
3. $2,500 for LLCs with total gross income of at least $500,000 but less than $1,000,000;
4. $6,000 for LLCs with total gross income of at least $1,000,000 but less than $5,000,000;
5. $11,790 for LLCs with total gross income of $5,000,000 or more.
Although the fee is relatively small, one must consider that the fee is assessed against gross revenues, not profits. This means that the fee is due whether or not your property is profitable. For a property with high revenues but narrow profit margins, the fee would reflect a higher portion of the property’s profitability than it would on a property that is highly profitable. For example, a company that owns an office building with revenues from rent totaling $1 mil, but a mortgage of $995,000, would actually operate at a loss after the $6,000 fee was imposed. Furthermore, the fee would be particularly irksome for those companies that foresee incurring losses in their early stages of development.
A Possible Strategy if Gross Receipts Exceed $250,000
For the vast majority of investors, the CA LLC fee should not dissuade you from forming an LLC. If, however, the impact is severely detrimental, there are several potential solutions that may be explored. A competent attorney or accountant may be able to work with you to avoid this fee. One method may be to form a Limited Partnership. The partnership should be set up with an LLC as the General Partner (assuming liability) and the owner(s) of the property as the limited partner(s). By forming a limited partnership with an LLC acting as the general partner, the landlord can likely avoid the higher fee imposed on an LLC while still protecting his/her personal liability. While this may be a possible solution, it is strongly recommended that you consult with an attorney or accountant regarding the best course of action.
While there are indeed risks associated with real estate, with intelligent decision-making and thoughtful preparation, real property can be a valuable investment. The first step though, is to make sure that you have adequately protected yourself and your property. We hope that this article helps property owners begin to discover the various ways in which one may hold investment property, as well as the protections and benefits provided by such ownership.
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POSTED BY P. J. JAVAHERI, ESQ. AT 3:58 PM