Articles Posted in Commercial, Real Estate and Construction Loans

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Last November, I was working closely with one of our clients and their real estate lender to purchase a large property in the San Francisco Bay Area. I formed two California limited liability companies for the transaction. One LLC was the investment entity that was going to own the property, and the other was the management entity that was going to hold the sponsor interests in the deal. Both entities had to be properly and fully formed so that we could obtain good standing certificates from the Secretary of State and be in position to issue legal opinions for the lender. During the due diligence period, our client discovered something about the property that was not what had been represented to them by the seller of the property. As a result of this information, the purchase fell through.

Fortunately, despite all of the other costs expended on pursuing this property, the client had not yet paid the $800 franchise taxes for each of the two LLCs we formed. In California, if an LLC meets certain requirements it may cancel its Articles of Organization within 12 months of the filing by filing a Short Form Certificate of Cancellation with the Secretary of State, and avoid paying the first year’s franchise taxes. These requirements include:

– The California LLC has no debts or other liabilities (other than tax liability);
– The assets, if any, have been distributed to the persons entitled to them;
– The final tax return has been or will be filed with the Franchise Tax Board;
– The California LLC has not conducted any business since filing the Articles of Organization;
– A majority of managers or members, of if there are no managers or members, then the person who signed the Articles of Organization, voted to dissolve the LLC and

– If the LLC has received any payments from investors for LLC interests, those payments have been returned to the investors.

Source: Spidell’s California Taxletter, Vol 34.11, Nov. 1, 2012.

Because our client met all of these requirements, we were able to cancel the LLCs without paying the $1600 ($800 x 2) in California franchise taxes. If, on the other hand, the client had already paid the taxes, we would not have been entitled to a refund. With this in mind, sometimes when forming an LLC it may be better to wait until the last minute before the franchise taxes are due before paying them to make sure the business is going forward, as long as you either pay them before late fees would be imposed, or you are willing to incur late fees in the event your LLC does not qualify for the short form cancellation.

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An investor bought an apartment building in San Jose and the broker wanted to send flowers for the occasion. A large bouquet was delivered to the buyer’s office with a note that read, “Rest in Peace.”

The buyer was irritated and called the florist to complain. After he had told the florist of the obvious mistake and that he was not pleased, the florist said: “Sir, I’m really sorry for the mistake, but what I’m more concerned about is . . . there is a funeral taking place today, and they have flowers with a note saying, “Congratulations on Your New Apartment!”This amusing joke is a good way of reminding us that both real estate and business deals continue to be closed in the Bay Area. As a banking, real estate and business lawyer representing parties to these transactions, I am very aware, and I expect most readers are as well, that financing continues to be a critical part of making a successful deal. During the robust period prior to 2008, one way parties garnered additional leverage in structuring real estate transactions was to utilize so-called mezzanine financing, in which the collateral securing a junior layer of debt consisted of the ownership interests in the borrower rather than the real estate. When the borrower was a limited liability company, this junior loan collateral could be secured through a pledge of the membership interests the owners held in the borrowing LLC.

The concept of using mezzanine debt to enhance leverage has not gone away. However, recent cases looking at transactions structured several years ago have curtailed the latitude of mezzanine lenders (“Mezz Lender”) and improved the position of the senior secured lender (“Mortgage Lender”) in the event problems arise after loan closings. If you are a Mortgage Lender holding real estate collateral, this may make it more attractive for you to enter into a transaction involving mezzanine financing. If you are a Mezz Lender or a borrower seeking to obtain and use mezzanine financing, obstacles now exist that were not there – or at least not believed to exist – before the markets collapsed in 2008.

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