ALI-ABA Course of Study Modern Real Estate Transactions. July 25-28, 2007 San Francisco, California

Transcription

1 767 ALI-ABA Course of Study Modern Real Estate Transactions July 25-28, 2007 Managing Investors' Liabilities in the Real Property Venture By Caryl B. Welborn DLA Piper Rudnick Gray Cary US LLP

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3 769 MANAGING INVESTORS LIABILITIES IN THE REAL PROPERTY VENTURE Introduction - 1- By Caryl B. Welborn Law Offices of Caryl B. Welborn Caryl B. Welborn May 1998 Your client wishes to form a joint venture to develop and manage a real estate project, and asks you to structure the venture to minimize his or his company s liability. Unless you practice in one of the handful of states in which they are prohibitively taxed, you probably will first consider forming a limited liability company ( LLC ) because of the fact that its members generally do not become personally liable to third parties for the venture s obligations. But a number of other factors affecting liability must also be considered in both the decision as to which entity should be chosen for the venture relationship as well as how it should be structured. These include the investor s ability to lose its financial investment based on acts of the other members, and the investor s potential liability to its co-venturers for violations of implied and express duties. This piece examines the potential exposure of the investor in different entities by virtue of venture liabilities to third parties as well as duties to co-investors, and the ways in which this exposure can be managed in the venture s governing documents. It includes a discussion of certain liability-related variables involved in selecting different types of ventures or entities as the investment structure, including the LLC, the limited partnership ( LP ) and the limited liability partnership ( LLP ). References to members in this article are meant to include any level of investor in a venture, including limited or general partners in an LP or LLP, and members or managers of an LLC. In defining the investor s potential liabilities in partnership relationships, this article generally looks for statutory guidance to the uniform acts, namely, the Uniform Partnership Act of 1914 ( UPA ), enacted in almost all states largely unchanged, the Revised Uniform Partnership Act of 1994, as amended in 1996 ( RUPA ), now enacted in approximately 20 states with slight changes, and the Revised Uniform Limited Partnership Act ( RULPA ), adopted in its core concepts in most states (although now undergoing further revision). Because the Uniform Limited Liability Company of Act of 1994 ( ULLCA ) has not been widely accepted and the LLC statutes vary greatly from state to state, a number of references to the LLC governing statute will be to that of my 1

4 770 home state of California. Although the trend in entity formation certainly favors LLCs, and thus the provisions of the UPA or RUPA may seem irrelevant, it is important to note that a significant number of the provisions of existing LLC statutes (for example, those of California), as well as the ULLCA, are based largely on RUPA. In part because of RUPA s relatively lengthy drafting history and resulting high level of commentary, its guidance is particularly useful. Also, circumstances may favor structuring the venture as a partnership composed of LLCs or other entities, again bringing general partnership rules into play. I. Exposure to Third Parties: How the Venture Becomes Liable for Members' Acts An entity can act only through its members, and thus only the members can create its liabilities. Some or all members of the venture must have implied or apparent authority to act on behalf of the venture, and may also have express authority to conduct venture business. When co-venturers are well known to each other, there is less concern over the members creating unwanted venture liabilities due to implied authority. In fact, general partnerships were prevalent until the mid-to late 1980 s, indicating little regard for a co-venturer s creating liability of the venture or even its venturers. Times clearly have changed, due to cyclical changes in markets, as well as the proliferation of alternative venture structures and related methods of avoiding liability. Now, investors are more concerned with the ability of other members to act on behalf of the venture, and the resulting liability that may be created. Investors can and must consider what level of authority will be implied on the part of different members, whether that authority meets the parties expectations and the needs of the venture s business, and how that authority might be eliminated or changed under applicable statutes A. Implied and Apparent Authority: Who has Authority For a business organization owning real property, the automatic and apparent authority of certain members to act for the entity in ways that could bind the entity, such as obtaining credit or selling or leasing property, may pose significant problems, although the exercise of apparent authority generally should result in entity rather than personal liability. General partners of partnerships have defined implied or apparent authority under the statutes to act on behalf of the entity. The general partner traditionally has expansive implied authority, a status which is continued under RUPA. UPA Sec. 9; RUPA Sec. 301; RULPA Sec. 403(a). In contrast, limited partners have no implied or apparent authority to act on behalf of a partnership. 2

5 771 In LLCs, either members or managers may be designated with agency authority. If the LLC appoints managers, only the managers have statutorily granted apparent authority. Under most statutes, unless the filed articles of organization provide for managers, every member probably will be considered an agent of the LLC (see ULLCA Sec. 301, N.Y. Law Sec. 412(a), Cal. Corp. Code Sec ). Each member will be presumed to have complete authority to act on behalf of the LLC. Indeed, in Delaware the rule that all members have absolute authority in relation to third party dealings remains true even if the LLC is managed by managers. Del Stat. Sec Thus, there is a significant difference in implied authority in certain LLCs relative to the limited partnership. As a result, for all but the most closely held entities, real property investors would want their LLC to be manager-managed. Because it is not clear that Delaware has a surefire way of restricting authority and management to a select group, Delaware may not offer the statute of choice despite its otherwise contract-based approach. Statutes or common law other than the entity formation statutes must be considered to some extent in the area of implied authority. In particular, principles of agency overlap concepts of implied authority. As RUPA clearly states: Each general partner is an agent of the partnership for the purpose of its business. RUPA 301(1). Implied agency authority may be even broader than statutory authority. The members need to remain concerned about the exercise of apparent authority by a member following his departure. Under RUPA and RULPA, and certain LLC statutes, a member may withdraw from the entity without causing its dissolution. RUPA has added a new concept and related structure of dissociation of a partner, which occurs when a partner withdraws without dissolution of the partnership. Under RUPA (Section 702), a dissociated partner continues to have authority to bind the partnership to third parties for a period of two years after dissociation in transactions that otherwise would have bound the partnership, provided that the third party reasonably believed that the dissociated partner actually was a current partner and did not have constructive notice of the dissociation based on a filing or recording (Sec. 704(c)). There is no comparable provision in the UPA regarding the authority of terminated partners. Many LLC statutes do not specifically cover the subject. After dissolution of the entity, the rules change again. The UPA was complex with respect to the means by which a partner s authority to act on behalf of a dissolved partnership terminated, and required determinations such as whether a creditor had extended credit pre-dissolution. UPA Sec. 35. These rules have been eliminated in RUPA in favor of a statement that actions by a partner will bind the partnership if the third party lacked notice of the dissolution or if the acts are appropriate for winding up the business. RUPA Sec As discussed below, a statement of dissolution provides an important method of furnishing constructive notice of the removal of authority. Again, many statutes do not specifically deal with this issue in relation to LLCs Typically, the law of the state of formation governs the internal affairs of the 3