A Matter of Trust – Issues for Boards When Owners Transfer Apartments to Trusts, LLCs, & Other Legal Entities
Why Are So Many People Considering Transfers to Trusts and LLC’s?
1. Speed up Estate Transfers – Transfers to trusts avoid delays in probating assets under a will; a Trust is also easier to amend and provides more flexibility in changing beneficiaries than wills do
2. Tax Planning. – Transfers to family managed LLC’s allows gifting of minority interests while you continue to control, and valuations of transferred interests are reduced because the transferee can’t make decisions. For high-end owners, transfers to Charitable Trusts may allow the owner to transfer appreciated assets, take certain immediate deductions and preserve future income.
3. Medicaid Planning. – To qualify for Medicaid if you need long-term care, you need to reduce your estate below very low federal maximums. [There is a 5+ year “Look-back” period for trust transfers, so need to plan early.]
4. Business Reasons – Structuring income and expense deductions for business, liability protection, e.g., to allow subleasing to a related entity or license agreements (e.g., for doctors).
Why Does Entity Ownership Matter to a Co-op or Condominium?
1. Liability of Owners to Association – Moving from having an individual at risk to having an entity at risk. The entity could be stripped of assets. Association wants to preserve access to assets of both the entity and the individual, to keep “skin in the game” for the principals of the owner.
2. Potential to Evade Restrictions on Transfers – Interests in the owning entity can be transferred without changing the name of the entity [Board of Directors of Big Deal Realty on Greene Street, Inc., v. 60G 133 GREENE STREET OWNER, LLC, 135 N.Y.S.3d 306, Slip Op. 50885 (U)]
3. Uncertainty about Who Has Authority to Represent Owner – Multiple officers, partners, etc. giving conflicting instructions.
4. Uncertainty about Persons Entitled to Occupy the Unit – If an entity owns, who can occupy? Employees? Officers and Directors? Members? “Guests” of Entity? Families of all of them? And for how long?
5. Preserve Sense of Community. Some Associations believe that having members who are not individuals erodes the sense of community of the building as in “we’re in this together.”. Some are conceding to trusts, but not LLC’s.
6. Liability of Owners to Neighbors. Unlike the Association, other owners can’t demand that an individual guarantee the obligations of an entity owner to them. Therefore an entity owner has reduced liability exposure to neighbors.
Where Does a Co-op or a Condo Get the Power to Regulate Ownership and Transfers?
1. Co-op – Easy. Board has right to approve or reject any transfer in its discretion, so can set any conditions it wishes for approval.
2. Condo – Less obvious. Need to review the language of the By-laws relating to the permitted use of the Unit, the occupancy of a Unit, the powers of the Board, and the scope of the Board’s right of regulate leases.
– A Unit can only be used for “residential occupancy.” How can an entity “occupy” anything? Therefore any use of a Unit by an individual is governed by the limits on permitted occupancy and leasing in the By-laws.
– For example, if an employee of the entity Owner stays overnight, how is that different from an AirBNB rental? Occupancy of an entity-owned Unit by a natural person is a form of lease or license, regardless of how low the rent payable may be. Therefore the Condo Association can exercise its right of first refusal or claim a violation of short-term rental laws in multiple dwellings.
– This option might not be available to every Condominium. Some Condo documents specifically state that if the unit is owned by a non-individual, it can be occupied by the principal, officers, or even employees. In those cases the Condo needs to determine if those rights are being abused, e.g., for weekly stays by different employees visiting the City, or by extended family members of a principal. Transient occupancy by unspecified third parties may violate the spirit of the Condo documents, if not the express language.
ASK YOUR ASSOCIATION’S LAWYER TO CHECK YOUR CONDO DOCUMENTS.
What Should a Board Require When Someone Seeks to Transfer to an Entity?
General Principle: Seek to conform the rights of the entity to the rights of individual owners.
1. Occupancy Agreement.
a. Specify who is permitted to live in the Unit. Check your governing documents. They should parallel the rights granted to individuals, e.g., immediate family, one other adult, parent or child. Check your policy about allowing occupancy by a family member without the individual owner being present, e.g., children buying for parents or vice versa, and conform if possible.
-Specify when are changes of occupants are subject to Association notice or approval. How do you treat guests, or roommates of owners? Again, conform.
b. Specify conditions for transfers that either trigger or do not trigger Association approval or waiver rights. Make sure that transfers of majority interests or control of the entity owner are considered transfers of the Unit. Determine which transfers require consent or submission of waiver request under governing documents (and which do not) and conform. Consider what happens to the entity upon the death of the principal. What procedures are followed, and what rights of approval or review does the Association have?
c. Technical points: Jurisdiction and venue, authority to act on behalf of the entity, other technical legal issues.
d. The Agreement terminates upon transfer of the Unit to a natural person.
e. Clarify who has the authority to act for the Owner, to avoid conflicting instructions.
f. For trusts, you want preserve the Association’s access to Trust assets. Many trusts have “spendthrift clauses” that prohibit creditors from accessing the interest of a beneficiary in a trust. If the Trustee is a beneficiary, this could affect the Co-op. In contrast, a Revocable Trust does not limit access by creditors.
2. Personal Guarantee. This is more customary for Co-ops than for Condos, since Co-ops can impose arbitrary conditions for consent. The principal of a prospective owner might object to giving a personal guarantee to a Condominium, but feel free to ask for one.
3. Acknowledgment – That the entity is subject to the provisions of the governing documents; that in case of a conflict between the governing documents and the Trust or Operating Agreement, the governing documents will prevail; and that transfers are subject to the requirements of the governing documents. A little bit of belt and suspenders, but makes clear what the entity is agreeing to.
Conclusion: Should Associations be Concerned with Transfers to Entities? Are the Risks to the Association Materially Increased by Entity Transfers?
1. For the most part, no. The Co-op Board retains a first lien against the apartment, and recourse against the guarantor. The Condo Board retains the same rights against the unit owner as it had against any owner before, although unless a guarantee has been signed, the assets of an entity owner could be reduced more easily than the assets of an individual owner. (But remember that the Condo never had the right to prohibit such a conveyance; most of the time its legal recourse arises post-transfer.) The Occupancy Agreement is a useful tool to help to clarify the parties’ respective rights and obligations.
2. One subtle potential disadvantage is not to the Association, but to neighbors. Unlike the Association, other shareholders or unit owners can’t compel the new owner to give personal guarantees, so in the event of a conflict, they may have reduced recourse against the entity owner. They can’t pierce the corporate veil if they have (say) a damage claim and the unit has no equity. But this is simply an argument for the Association to require all owners to carry homeowners insurance.
In sum, Associations must be prepared for more of these requests, especially as their population ages. There are practical and legal ways to deal with them.
For more information, contact: