Updated on July 8, 2022
Many residential and commercial property owners in California are familiar with the idea of using an LLC (limited liability company) to hold and manage real estate. In this post, we will discuss what you can do with a limited liability company (LLC), how to avoid pitfalls when entering into a transaction with a limited liability company, and what to do if you believe you are dealing with fraud by someone hiding behind a limited liability company.
Once the articles of organization of the limited liability company has been filed with the Secretary of State, the LLC has legal capacity to enter to a variety of real estate transactions.
Through the acts of the manager or managers provided in the articles of organization or the operating agreement, the limited liability company can purchase, sell, lease, hold, use, mortgage, and transfer any interest in real and personal property. It can also issue notes, bonds, and other security interests on any of its assets.
Property owners favor limited liability companies because the resulting business entity is legally separate from its owners, providing what is called “limited liability protection.” Generally, if the limited liability company incurs obligations and liabilities, the owners’ personal assets (such as other real property and bank accounts) are protected from creditors.
Because limited liability companies can be used as a shield for assets of individuals and companies, it is possible for individuals and companies to misuse the business formation for means of committing fraud and other wrongdoing. A limited liability company can provide an extra layer of anonymity for individuals and companies and it may protect their assets from victims and creditors. What can you do to avoid the pitfalls of doing business with a limited liability company?
As they say, the best defense is a good offense. At the outset of the transaction, do your due diligence. Verify the identity of who you are dealing with. Is the person authorized to act on behalf of the limited liability company? Verify their representations to you by reviewing the limited liability company’s articles of organization and operating agreement. Visit the Secretary of State’s website to check if the limited liability company’s filings are up to date and who is listed as the agent for service of process and who is signing off on the annual statements of information. Make sure the company is not in forfeiture or suspended by the state’s Franchise Tax Board. Make sure you collect information and verify information about the members of the LLC. To further safeguard your rights, negotiate for a personal guarantee by the owner or obtain owner’s personal assets (such as in real property) as security.
The limited liability protection of a limited liability company may leave a creditor (for example, someone like a business partner, lender, judgment creditor) without much recourse in the event that the assets of the limited liability corporation have been exhausted and there is nothing remaining in the LLC to pay the creditor.
There are particular circumstances, however, where the court may disregard the corporate entity (the LLC) and hold that the individual (or company) who owns or operates the LLC is the alter ego of the limited liability company. The result may be a finding that the individual has alter ego liability—which means the owner is personally liable for the obligations or liabilities of the LLC.
Two conditions must be met for a finding of alter ego liability: First, there must be a unity of interest and ownership between the owner and the LLC, such that the corporation and its owner does not in reality have separate personalities. Second, there must be an inequitable result if the LLC’s bad acts are treated as those of the LLC alone.
The importance of conducting thorough due diligence prior to entering into business with a LLC becomes clear here. Making a case under alter ego theory often involves a showing of facts about the owner: whether the owner commingles personal funds and that of the LLC’s; the owner and LLC have identical officers and employees (if the owner of the LLC is a company); whether the LLC was sufficiently capitalized; and whether the owner follows corporate formalities and truly treats the LLC as a separate business.
As a closing note, there are a number of tax and legal considerations that an individual must consider before creating a limited liability company to hold property or transferring title of a property to a limited liability company. Talk to your accountant and attorney before starting the process.