Corporate Formalities

When you organized your business, you likely chose to do so using a corporate, limited liability company, or limited partnership structure.  You did this in an effort to insulate your personal assets from the liabilities of your company.  Simply forming your company may not be enough to protect your assets. It is imperative that you undertake certain “corporate formalities” in order to ensure that your company is indeed treated “separately”.  Some of those formalities include:

• Holding an annual meeting; 
• Keeping records of those meetings (e.g. company minutes); and 
• Maintaining a “company book”.

You can focus on operating your business, and let our office host your annual meeting, record your annual minutes, and maintain your “company book”.  Please contact us to schedule your annual meeting.  

If you are a lender or title company, please suggest that your clients contact us to discuss maintaining their company records.

The Importance of Filing Your Texas Franchise Tax Return

When you organized your business, you likely chose to do so using a corporate, limited liability company, or limited partnership form. You did this in an effort to insulate your personal assets from the assets of your company. Let’s say an employee of your company is involved in an accident in which the employee is deemed “negligent” (ideally, your company would have insurance covering such an accident). A lawsuit by any injured parties would be against your company, rather than you individually. As I have mentioned in prior newsletters, it is imperative that you undertake certain “corporate formalities” in order to ensure that your company is indeed treated “separately”.

One such formality is the filing of your annual Texas franchise tax return (even when no tax is due). A failure to file that return on an annual basis will cause the State of Texas to revoke your corporate privileges, resulting in your company being synonymous with you individually.

Rights of Third Parties to Assets Purchased by Your Company

When your business purchases assets, or when you purchase a business, you likely assume that the assets are being purchased "free and clear", but that is not always the case. A search of UCC filings with the Secretary of State and the applicable county real property records can likely rule out bank liens. However, litigation claimants, governmental agencies (e.g. the State Comptroller with regard to unpaid Sales Taxes) and other potential third parties make up a secondary pool of parties with potential rights in purchased assets.
You can often have your seller provide warranties and representations relating to any such claims and hire companies in the business of performing detailed searches to rule out such claims. We always recommend using competent legal counsel in order to draft such warranties and representations and to review such search results.

Ground Leases

What is a ground lease? Under a typical ground lease, a landlord owns a parcel of raw land, which it leases to a tenant for an extended period of time (e.g. 30 years, 99 years, etc.).  The tenant generally obtains its own financing (either from a third party or the landlord) to construct improvements (e.g. a building) on the property, and the title to those improvements remain with the tenant, rather than becoming part of the real estate.  At the end of the term, the improvements become part of the real estate and belong to the landlord.

Why would a property owner choose a ground lease?  In an economic environment where land prices have fallen, a ground lease could allow a landowner to delay the sale of the land until a profit (or a larger profit) can be realized from a sale.  In other words, the property owner could lease the property now, and sell it later. 

Why would a tenant choose a ground lease?   Under a ground lease, the tenant does not incur property acquisition costs.  In other words, a loan obtained in constructing its building would not need to include the cost of acquiring the property.  Also, a tenant in a manufacturing business may only need the use of the property for a finite period of time and may have no desire to make an investment in real estate.

Whether you are a property owner, prospective tenant or lender, a ground lease can be a complicated endeavor, requiring the advice and drafting skill of sophisticated business attorneys in order to address your specific needs. 

Operating Expense Caps in Commercial Leases

If your business leases space as a tenant in a shopping center, office building or industrial warehouse, the landlord's costs of operating the center, building or warehouse are likely passed through to your company. In other words, you probably pay both base rent and operating expenses. The operating expenses include costs that cannot be controlled by the landlord, such as taxes and insurance, and costs that can be controlled by the landlord, such as the cost of the landlord's employees. Oftentimes tenants, especially tenants that are represented by an attorney, negotiate an operating expense cap, in which case, the increases in operating expenses under the lease would be capped at, for example, 10% per year.

Whether you are a landlord or a tenant, the negotiation of an operating expense cap can be extremely complex, and we highly recommend the use of sophisticated counsel in connection therewith. There are many working parts in a well-drafted expense cap equation. For example,

1. The landlord cannot practically agree to place a cap on expenses that are wholly outside of its control, such as taxes and insurance. This often results in application of the agreed cap to "controllable" expenses only. It is imperative that the scope of the term "controllable" is clearly established in the lease.

2. Without well-thought-out language, the mathematics underlying the cap is often unclear. For example, assuming operating expenses of $1,000 in year 1, what result does a cap of 10% per year have in year 3 - $1,200 (a $100 increase each year) or $1,210 (the $1,100 cap of year 2 times 10%)? This will matter more in years 5, 6, etc.

3. The amount of the cap can typically range from 3% to 15%, depending on the landlord, the local market, the type of lease, etc. Place your trust in counsel having experience with those factors.

4. The lease often contains a "gross-up" provision, which allows the landlord to increase the operating expenses to a hypothetical amount that would have been incurred by the landlord assuming full occupancy. While this is a legitimate requirement by the landlord, there are pitfalls to the tenant if such a provision is not drafted properly.

These issues are very important, but they are complex. Focus your energy on your particular line of business and let us handle these details, as this is our line of business. 

The Series Limited Liability Company

As an entrepreneur, multiple business owner or real estate investor, you probably own several investments, each through a different limited liability company (LLC), in an attempt to limit your liability with respect to each business or property.  For each LLC, you likely file a separate form 1065 with the IRS in April and business tax return with the State of Texas in May, and you have likely spent significant funds toward formation costs for each LLC.  With numerous LLC's, this can be a paperwork nightmare and quite expensive.

A series LLC is a new creation of the Texas legislature (as well as the legislatures of a handful of other states), that is designed to address these issues.  A series LLC is designed as a single umbrella entity, which is organized in units that each are separately accountable, housing their own level of liability protection, financial structure, managers and members.  For example, if you own a shopping center, a storage rental property, a construction company, and a cleaning service company, the series LLC is designed so that you can own all of those businesses through the same LLC, with the shopping center being categorized as Series A, the storage rental property being categorized as Series B, etc.  If someone is injured on the job in connection with your construction company (Series C), in theory, that injured party would not be able to pursue the assets or cash flow of the cleaning service business (Series D), for example.

On the other hand, if you are doing business with a series LLC, it is imperative that you understand that only the specific applicable series (e.g. series B) is on the hook for the obligations under your respective contract.  A potential solution is to require the LLC as a whole (or some other specific series) guaranty those obligations in order to improve your likelihood of having sufficient recourse in the event the business with whom you are under contract defaults.

The series LLC is a new legal creation, and the law surrounding it is somewhat unsettled and fluid, but it may soon become a very popular way of organizing businesses in Texas.  If you wish to form a series LLC or have concerns in doing business with one, please retain competent legal counsel to assist you with your legal concerns.

What Are Rollback Taxes?

Many land owners do not quite understand the nature of rollback taxes.  To understand rollback taxes, it is important to understand certain exemptions offered by local property taxing authorities, for example, the agricultural exemption (often referred to as the "ag" exemption).  Subject to varying qualification requirements (e.g. minimum land size) of different counties in Texas, a land owner who grows timber, raises cattle, grows a crop, etc., on their land for a certain number of years (e.g. the last 3 years) can file an application with the applicable county to be considered an agricultural producer, entitling the land owner to a significant property tax break.  Often, land owners with such a designation pay 1/4 or less of the property taxes applicable to non-exempt property.  It is also important to understand that an applying land owner need not be in engaged in an agrucultural business to be entitled to such an exemption.  For example, they could simply lease their land to a farmer, timber grower or rancher.

Land that is exempt is subject to a special tax, applicable at the time the use of the land changes.  This is a rollback tax.  Essentially, the rollback tax is the difference between the amount the land owner owed in property taxes and the amount the land owner would have owed had there been no exemption, for each of the five tax years preceding the change in use.  As most can imagine, that can be a very large tax.

The issue of rollback taxes often arises in the context of a purchase or sale of real property.  Take, for example, a property owner who leases 20 acres to a cattle rancher, the property is located on the corner of two major roadways in a rapidly developing area, and the landowner is considering selling the property to a major retail developer.  Who pays the rollback taxes?  Unfortunately, there is no clear answer to this question, as it largely depends on who technically changes the use of the property.  In the above example, if the land owner only removes the cattle and takes down his fence to bring water and sewer to the property to better market it for retail development, does this constitute changing the use?  The answer is "maybe", as it largely depends on the entire set of facts surrounding the land sale and subsequent use.  It is very important to retain competent legal counsel to negotiate provisions in your purchase and sell agreement to clearly allocate the burden of rollback taxes.