The limited liability company (LLC) form is one of the most prevalent business entity forms in the United States and continues to rise in popularity, especially for commercial real estate. In recent years, the process for forming LLCs has become simpler in many states. In Kentucky, for example, the cost to organize an LLC is $40.
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 “[Name] 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, including the obvious additional layer of liability protection. However, there are several issues real estate investors and owners 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 the 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 up to date and compliant 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 Kentucky, 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 Kentucky Secretary of State may administratively dissolve the LLC after providing the LLC notice. After an LLC is administratively dissolved, in Kentucky 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. KRS 275.300. 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 Kentucky, it can achieve good standing again by filing an application for reinstatement and paying $100.00 and an additional $15 for each delinquent annual report. Such reinstatement will relate back to the time of administrative dissolution. KRS 14A.7-030.
However, Kentucky doesn’t protect your LLC’s name for any time following administrative dissolution. This means if an LLC is administratively dissolved the name of the LLC 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 Kentucky owned by LLCs that have been administratively dissolved and are beyond the point of reinstatement. These LLCs still hold real property in the name of the LLC and sit waiting to finally liquidate their asset. The only thing the LLC can do with the property is convey it. The Kentucky 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. 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 several 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, but can be 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.
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 significant expenses in the event that their entity falls into dissolution. This problem, which arises from time to time, will likely 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 LLC 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 contact out to our office for assistance.