Texas Series LLCs and Your Due on Sale Clause
June 8, 2012 | By Kevin Vela
As I have discussed in my earlier blogs on Texas Series LLCs, series LLCs are a powerful and efficient asset protection tool, and are rapidly becoming the preferred entity vehicle for real estate investors. However, because they are still in their infancy in Texas, series LLCs can often raise questions that have yet to be answered.
One question I’ve been intrigued by is what sort of effect the transfer of property from an individual or other entity to cells within a Series LLC would have on the mortgage on the property; specifically, would transferring property into a Texas series LLC trigger the due-on-sale clause found in most, if not all, loan agreements?
A due-on-sale clause allows a lender to accelerate payments on loans in the event of a transfer of property title. The rationale behind these clauses is twofold. First, it allows lenders to mitigate their own risk and accelerate the loan if the new buyer or owner isn’t a good borrower candidate (usually, when you transfer title you are selling the property, and the existing mortgage gets paid off at close). Second, the exercise of a due-on-sale clause allows the lender to keep its loan portfolio at more nearly current interest rates.
While a due-on-sale clause doesn’t mandate that a lender accelerate the loan, it does give the lender that option, and in this economic environment, this is something that banks have cause to take a second look at. Because a cell within a series LLC could have different owners, directors, and banking and taxing methods than the original borrower (whether an individual or entity), it’s possible, even likely, that a lender would consider the property as being owned by a new owner with a different risk consideration.
Thus, we see three scenarios:
1) You transfer the property into the cell within your Texas Series LLC and pray that the lender or your bank does not find out; or if they do, that they do not care. WE DO NOT ADVISE THIS (in fact, nothing in this article constitutes legal advice, please consult with an attorney before making any transfer decisions), but as long as the lender is still receiving payments on the property, they usually do not care who is signing the checks. Your bank may become aware of the transfer through insurance notices, property tax assessments, or routine public property record audits.
2) You call your loan officer, explain that you would like to transfer the deed on your property into a cell within a Texas Series LLC and ask them how to do so. In our experience, some banks approve it for no charge, some charge a fee (usually around $500) to cover the paperwork on their end, and others require that the Series LLC cell qualify separately to take over the existing loan.
3) The bank refuses the request and then you run this risk of the note being accelerated if you move forward despite the bank’s denial.
In the end, if you form a Texas Series LLC for the purpose of transferring existing properties into cells within the series you might run in to a situation where your lender will attempt to apply the due-on-sale clause in your loan. This hasn’t been addressed by statute or case law in Texas yet, but I would assume that’s on the horizon, and this question might be answered sooner than we think. In the interim, please consult with an attorney and your bank before transferring any properties into Texas Series LLCs.
Posted in Real Estate, Texas Series LLCs
Kevin Vela is the managing partner at Vela Wood. He focuses his practice in the areas of venture financing, mergers & acquisitions, corporate law, capital raises, and real estate investment activities. You can see Kevin’s attorney profile HERE.