Does your LLC protect you from tort claims?

Individuals starting out in business may misperceive and exaggerate the protections that an LLC offers.  A Limited Liability Company (“LLC”) may not protect you from ‘torts’ or ‘negligence’ claims.   An LLC may offer significantly greater protections from ‘contract’ claims, i.e. ensuring that business owners do not become personally liable for debts of the company.  Take for example a commercial lease agreement, which is a contract.  You decide to open a small business selling goods or services.  You form a single-member (owner) LLC.  You approach a perspective landlord who has an appropriate space.  Your intent is to rent the space, allowing customers onto the premises to buy goods or services from you.    A lease is signed, and the LLC is identified as the tenant.  You, personally, do not sign as a party or guarantor of the lease agreement.  Here, if the LLC goes out of business and doesn’t pay the rent, the landlord will have difficulty collecting against you personally (attaching your wages, bank accounts, or other property) unless the landlord can ‘pierce the corporate veil’, which can be quite difficult.  However, if you personally guarantee the lease payments to the landlord, then you can be made responsible if the LLC does not pay the rent.  In this case the LLC may offer protections depending on how the contract is written.  Always look to see if there is a personal guarantee!

Tort / negligence claims are quite different from contract claims.  A director or officer who commits a tort, or directs the tortious act done, or participates or operates therein, is liable to third persons injured, even though liability may also attach to the corporation for the tort.  (See for example Sacred Heart University v. Voll, FBT-CV15-6048244, Hon. Michael P. Camp, Connecticut Superior Court J.D. Bridgeport.)  For example if an engineer operates an LLC, and he or she commits malpractice, causing a structure to collapse causing injury, then the injured will seek out damages for negligence or malpractice against the engineer.  The LLC may offer no protection, and insurance may be the engineer’s best defense. The same liability could attach to an owner of a restaurant whose poor sanitation practices cause illness.

An experienced attorney will tell you why an LLC is important, and why its protections are sometimes inadequate.  You must also maintain certain ‘business formalities’ to maximize the afforded protections of the LLC.  An LLC is just one tool to protect yourself.   As illustrated above, insurance is another significant tool.  What type of insurance you need, will depend in large part on the nature of your business and you should discuss this with a qualified commercial insurance agent.

If you are starting out in business you should speak with an experienced attorney to understand these nuances.  If you elect to form an LLC online, with no attorney consultation, you may be doing yourself a significant disservice.

Landlord / Tenant pre-termination “KAPA” Notice

The eviction process in Connecticut, begins with a Notice to Quit.  This Notice sets forth the reason why the Landlord is starting the Summary Process (eviction) case, such as for example “Non Payment of Rent”, or “Lapse of Time”.  The Summary Process (eviction) complaint is filed in court after a proper Notice to Quit is served.

However, on occasion, a “pre-termination notice” (also known as a KAPA notice), is required even before the Notice to Quit is served.

A “pre-termination notice” can refer to the notice that must be provided, under federal law, before a landlord is permitted to initiate eviction proceedings against a tenant who occupies federally subsidized housing. Connecticut law also requires a pre-termination notice under certain circumstances. See   General Statutes § 47a-15 (requiring a landlord to provide pre-termination notice to the tenant before filing any eviction action based, among other things, on alleged material noncompliance with terms of lease, unless the noncompliance involves nonpayment of rent or serious nuisance). This state statutory requirement, often called a Kapa notice, see Kapa Associates v. Flores35 Conn.Supp. 274408 A.2d 22 (1979), requires the landlord to give the tenant at least fifteen days to cure the alleged non-compliance before any lease termination becomes effective.

Mistakes made early on in an eviction case, might not be discovered until weeks or months later.  Working with an experienced attorney early in the process, is important in this area of the law.

Fire Sprinkler System Disclosure in Residential Leases

Connecticut residential landlords, take notice:

As of October 1, 2015, Connecticut law (Section 57 of bill 1502) requires that residential landlords include a notice in a rental agreement, as to the existence or nonexistence of an operative fire sprinkler system.   Further, if there is an operative fire sprinkler system in the dwelling unit, the rental agreement “shall provide further notice as to the last date of maintenance and inspection…”  The notices “shall be printed in not less than twelve-point boldface type of uniform font.”

 

 

 

Should I rent my home or condo, while I try to sell it?

To answer the question, ‘Should I rent my home or condo, while I try to sell it?’, consider these additional questions:

1) Do you have a mortgage? Does your mortgage permit you to rent the property?

If you have a mortgage, then in addition to your Promissory Note (your contract / promise to pay the mortgage debt), you signed a Mortgage at closing that gives your lender (“Mortgagee”) a security interest in your home. If this is a “uniform” security instrument then the Mortgage includes many promises.

Look for the following promise (or a similar clause), in a residential mortgage:

Occupancy. Borrower shall occupy, establish, and use the Property as Borrower’s principal residence within 60 days after the execution of this Security Instrument and shall continue to occupy the Property as Borrower’s principal residence for at least one year after the date of occupancy, unless Lender otherwise agrees in writing, which consent shall not be unreasonably withheld, or unless extenuating circumstances exist which are beyond Borrower’s control.”

No lawyer should ever tell you that you can breach a contractual promise, out of convenience.

If you rent your property before one year from the date of occupancy, you have breached your agreement and you risk the lender defaulting you. Lenders have a way of finding out that you have moved out of the property.

If your mortgage restricts you from renting, you will have to ask your Mortgagee for permission to rent. This will likely come with a cost. Good luck getting a large banking institution to agree to this. If your Mortgagee is a small bank, you will have a better chance of working something out, at a lesser cost.

2) Does your condominium association permit you to rent the property?

You may have signed an affidavit relating to occupancy of the property. Find out if the occupancy affidavit or condominium rules committed you to reside at the property, or if it merely asked what your current intention was (i.e. on the date you signed it). Find out if the Condominium Bylaws prohibit renting. You might need to determine if the occupancy affidavit is connected to / supported by, the Bylaws. It is possible that the association is trying to enforce a ‘no-renters policy’, but the association doesn’t have the authority to do this.

3) Will your homeowners insurance cover your loss, if the property is rented?

Assume the answer is “no”. It is crucial that you address this problem. You must keep insurance in place because it would be catastrophic if there were a significant loss that went uncovered during a rental period.

Ask your insurance agent if you can get a rider to allow rental, and find out the cost. You may have to change insurance companies.

4) What are the tax consequences?

Capital Gains:

If and when you do sell your property, your closing attorney will ask you a series of questions to determine if you are subject to capital gains reporting. To claim an exemption, you will need to answer (amongst other questions) that you have “owned and used the residence as my principal residence for periods aggregating 2 years or more during the 5-year period ending on the date of the sale or exchange of the residence.”

Occupancy need not be continuous, nor must the residence be the seller’s principal residence at the time of the sale. If you owned the home for two years, and then rented it for three years, you will likely qualify (if other criteria is met). However once the tenant stays longer than three years, you no longer qualify for the capital gains exemption.

Income Taxes:

Don’t forget about income taxes, for the rental proceeds (assuming your tenants actually pay – giving you income). Consult with your tax advisor to determine your own tax consequence (i.e. given your individual circumstances). Expect to start keeping receipts for all work done on the property. You are now operating a business. Also ask your tax advisor if interest paid towards your mortgage, will remain deductible.

5) Do you need to register your rental property with your municipality?

Many municipalities are requiring that tenant-occupied properties be registered. Expect to see smoke detector requirements, rights of inspection to determine compliance with building codes, and fees. You may have to get a “Certificate of Occupancy” each time a property is rented. As an aside, did you know tenants may be protected from eviction, if your property is not up to code?

6) What is the personal liability risk?

If someone is injured at the property, will they sue you personally? Can they try to attach your wages, or your bank accounts, or even your home? Do you need to convey the property to an LLC, to minimize your personal liability? What are the costs and benefits of conveying the property to an LLC? Is the hazard insurance coverage (See Question No. 3) sufficient to protect you from risk? Do you need an umbrella policy? What is the effect of conveying the property to an LLC, on capital gains when you sell? (See Question No. 4 and consult your tax advisor.)

7) Do I need a written lease?

The answer is “yes”. It is still possible to evict a tenant with an oral (month to month) lease, but with a written lease, you can enforce many more provisions that are important to you, such as: don’t keep pets at the property; don’t smoke; and don’t paint the walls mauve. Each of these actions by a tenant will cost you money. The eviction process will cost you money. With a written lease the eviction process should go smoother, but it is rarely easy.

In Connecticut, expect that the eviction process will take several months, even with a written lease, and expect that during this time your tenant will pay you nothing. The tenant is given a 10-day grace period to pay the rent, by law. If the rent is not paid within the grace period, you will need to serve your tenants with a “Notice to Quit”. There must be three intervening days between the date of service of the Notice to Quit, and the move-out date shown on the Notice, for a ‘Non-Payment’ eviction. If you don’t know the rules, you may make costly mistakes. For a lapse of time eviction, you will need to give the tenant until the end of the rental period, i.e. until the end of the month, for a month-to-month tenancy. This is only the first step. Now you need to sue the tenant who fails to leave voluntarily. This means filing a Summary Process Eviction Complaint, serving the tenants (again), waiting for the tenant to file their “Answer and Special Defenses”, which once filed (even if the tenant admits all allegations) entitles your tenant to a day in court. If you make a mistake, you may not find out until late in the process and you will need to start all over again. Think of the financial impact of 6-months with no rent from your tenant! If your tenant appeals the judgment of a trial court, the delay and cost is even greater.

8) Can I sell a tenant-occupied property?

Yes, but probably only to an investor. A potential investor will want to see that the existing tenant has been making consistent payments, and that you have a written lease agreement. Don’t expect an investor to buy the property if rentals are prohibited by the Condominium Bylaws. Also, a potential home-owner (non-investor) does not want to buy your property only to have to evict the tenants. See Question No. 7 to understand why.

Don’t expect your tenant to move out voluntarily just because you have sold the property, and don’t expect your Buyer of the property to be comfortable with the mere promise that a tenant will move out. Even if your tenant promises to move out when the property is sold, he/she probably won’t.

Nothing that a lawyer includes in a written lease agreement, will entitle you to a “quick” eviction. Tenants are not permitted to waive statutorily granted housing rights, and judges know this.

9) Can I get a mortgage loan, if I am already on a mortgage loan?

Ask your lender if you can be on two mortgage loans at the same time. Even if lending rules allow this, and you meet eligibility criteria, do you really want two mortgages? Talk to an experienced mortgage broker or lender, but also think about your long-term financial plans, and whether this is consistent with your plans and willingness to take on risk.

10) Will my tenant(s) pay me?

Just because there is a written lease does not mean you are guaranteed payments. Speak to an experienced attorney about drafting a lease, and getting security. You may also want to do a background check on your potential tenants. Your lease may require extensive discussions with your attorney which are beyond the scope of this short article.

11) Do I really want to be a landlord?

Dave Ramsey cautions against becoming a landlord ‘by default’ (i.e. falling into it, as opposed to deliberately becoming a landlord. He would also tell you not to own a rental property unless you can buy it wish cash.) Putting aside the cash / debt debate – Do you really want to be a landlord? If these eleven questions scare you, and you don’t want to take the time to understand all of the issues, you should not be a landlord. It is much safer to wait until the right buyer comes along, to sell your property. However don’t just wait for a sale. Find an aggressive, experienced real estate agent who will take control of the sale process. Your agent should tell you exactly how to show and market the property. Showing the property will be difficult when tenants paint the walls mauve and don’t clean up after their slobbering litter of Neapolitan Mastiffs.

In conclusion, renting a house or condominium while you try to sell it brings significant risk. Always understand these risks. Speak with your attorney, tax advisor, insurance agent, and experienced mortgage professional first.

Joel A. DeFelice is a partner at Marder & DeFelice Law Offices, LLC, located in Vernon, Connecticut.