A Dime A Dozen: LLCs and Commercial Real Estate

Posted by Ruari J. O'Sullivan on

The limited liability company (LLCs) form is one of the most prevalent business entity forms in the United States and continues to rise in popularity.   

For the past 30 years, the number of LLCs filing annual tax returns has increased by an average of 21% every year, with no signs of slowing.[1] In reality, the growth of LLCs has been even more pronounced than that; Treasury Regulation 301.7701-1-3, allowing LLC members to “check the box” to choose how an LLC should be taxed (and the real impetus to widespread adoption of the LLC form), was only effective as of January 1, 1997[2] and many LLCs are pass-through entities which do not require a separate tax return to be filed. Still, as of 2016, the number of returns filed by LLCs roughly matched the number of returns filed by S-corps, remarkable given that the LLC form is nascent in comparison to the S-Corp form.[3]

In recent years, the process for forming LLCs has become simpler in many states. In Georgia, for example, the cost to organize an LLC is $100, with an option to make the filing effective the same day for an extra fee. The form is streamlined and straightforward to fill out. The Georgia Secretary of State has also released its “State of Success” application for mobile devices, allowing users to search for LLC’s and file annual registrations from their phones. It seems likely that soon in Georgia people will be able to form LLCs on the go from their phones.

LLCs in Commercial Real Estate

The commercial real estate industry has done its share to foster this explosion of LLCs. Rarely, it seems, does a purchaser take commercial property in anything other than the name of a newly minted LLC. The corporate databases of each state around the country are littered with entities like “123 Main Street, LLC” or “Smith Property Holdings, LLC”. The reasons for using the LLC form in the commercial real estate context, and in many other contexts, are valid and plentiful, and the subject of many other articles online. Here, however, I want to address a few points real estate investors, owners and developers should be aware of when electing to hold real property in the LLC form.

The LLC used in the commercial real estate context is primarily a particular kind of LLC – namely, the single asset entity (SAE). As its name suggests, an SAE only has one asset. In the commercial real estate context, that single asset is almost always a parcel of real estate. Developers, investors, and management companies who deal with a broad portfolio of real estate holdings typically also have a broad portfolio of SAEs that they have to keep track of that match up to each real estate holding. Managing that portfolio of SAEs and keeping those SAEs straight and up to date can be burdensome.  Even for the investor or developer who only owns a single parcel of commercial real estate, the LLC was likely suggested as the ownership structure by their attorney at or near closing and may have since been entirely forgotten or neglected.  And while it doesn’t require much to maintain (requiring in most states only an annual registration and fee), it is nonetheless an obligation imposed by the state that can have consequences if ignored.

Risks of LLC Neglect in Commercial Real Estate

In Georgia, if an owner, officer or other authorized person of an LLC fails to file an annual registration on behalf of the LLC for one year, the Georgia Secretary of State may administratively dissolve the LLC after providing the LLC notice. After an LLC is administratively dissolved, in Georgia and in many other states, it is prohibited from carrying on business except that which is necessary to wind down and liquidate its business and affairs.[4] If during that time period, for example, the LLC enters into a contract or assumes an obligation that is not associated with the winding down of the business, it is possible that such action falls outside the scope of the LLC’s authority, meaning that the individual signatories, and not the LLC, are bound by that contract or obligation. Luckily, once an LLC is administratively dissolved in Georgia, it can achieve good standing again by filing an application for reinstatement and paying $250.00, and such reinstatement will relate back to the time of administrative dissolution.[5]

However, in Georgia, if an LLC does not file for reinstatement within five years after being administratively dissolved, it will be permanently dissolved and may not be reinstated.[6] The name of the LLC then becomes available for use again by anyone. For owners, members, or managers who have let an LLC go beyond the period of reinstatement, simply re-forming a new LLC with the secretary of state with the same name is not an appropriate solution – technically there are now two separate LLCs, one dissolved that still owns the real property or whatever assets it held before dissolution, and one new LLC that owns nothing.

Undoubtedly, there are parcels of land in Georgia owned by LLCs that have been administratively dissolved and are beyond the point of reinstatement. These LLCs still hold these parcels of property in the name of the LLC and sit patiently waiting to finally liquidate their asset. The only thing the LLC can do with the property is convey it. The Georgia Limited Liability Company Act provides that the member(s) or the manager(s) of the LLC, whichever one had authority to manage the LLC at the time of dissolution, may execute a deed conveying the real property in the process of winding up the LLC.[7] While that may sound relatively straight forward, in practice it may be troublesome for a purported owner of an LLC to prove the ownership structure of an LLC that has been dissolved for at least five years. If the governing documents were as neglected as the LLC, they may have been lost if there ever were any to begin with. If the governing documents are found, the age of the documents may raise questions about whether the ownership structure has changed in the intervening years. Often in these situations, what will be required from the dissolved LLC will not be dictated by statute, but by the title insurer who will be providing coverage to a prospective purchaser of the property held by the dissolved LLC and/or the purchaser’s lender. It’s typical that title insurers in this situation, whether or not the LLC was originally manager managed, will require a document executed by all of the persons or entities that are shown as members before the time of dissolution. This may not be a particularly burdensome hurdle for single-member LLCs (other than the extra cost required to analyze the effect of the dissolved LLC on title and confirm ownership), but can be extremely problematic if there are multiple members who have since themselves been dissolved or are now deceased. For LLCs operated by institutional managers on behalf of a disparate and numerous group of investor members, the signature of all members may approach an impossibility or require significant time and expense to capture. In the event all signatures can’t be obtained, the fate of the transaction is left in the hands of the title insurer, who may require more onerous assurances from the individuals intending to convey the property on behalf of the LLC.

Conclusion

Ultimately, what is often used as a simple, easy and cheap way to provide an extra layer of liability protection between a property and its owner(s) could end up exposing such owners to individual liability and require not insignificant expenses in the event that their entity falls into dissolution. This problem, which arises from time to time currently, will likely only continue to grow as LLCs become more prevalent, easier and cheaper to file, and as more time passes. Luckily these potential hazards can be easily avoided by filing an annual registration for the SAE every year. But, if your LLC has already fallen into dissolution and you need help understanding your exposure, reinstating your entity, or tracking down former members, or if your portfolio of LLCs has become unwieldy or disorganized, please feel free to reach out to our office for assistance.

[1]Trends in New Business Entities: 30 years of data”, Mark Little, July 5, 2016, Berkman Solutions

[2] “LLCs: Is the Future Here? A History and Prognosis”, October, 2004, GP/Solo Law Trends & News, Vol. 1.  No. 1

[3] Berkman Solutions.

[4] O.C.G.A. § 14-11-603.

[5] Id.; O.C.G.A. § 14-11-1101.

[6] O.C.G.A. § 14-11-603.

[7] O.C.G.A. § 14-11-611.