Due-on-Sale Clauses

Most attorneys are shocked and appalled when they find out that their clients have been doing business, sometimes for several decades, as sole proprietors. The attorney typically pleads with the client to register a corporate entity to do business under, typically a limited liability company or LLC.

As many clients are real estate investors or entrepreneurs, merely opening an LLC is not enough. Whatever assets are owned must then be placed into the LLC by deeding the property from the individual or sole proprietorship to the LLC. The clients are generally surprised, however, to find that they cannot also transfer their homestead and any property with FHA or conventional loans into the LLC. Instead, those properties are generally going to be put into a family trust, though there are other options to look at depending on the circumstances.

The reason that the client cannot simply transfer all properties into an LLC or LLCs is what is called the “due-on-sale clause.” This is a clause typically found in most mortgage agreements. An example of a due-on-sale clause is the following:

“If all or any part of the Property or any Interest in the Property is sold or transferred (or if Borrower is not a natural person and a beneficial interest in Borrower is sold or transferred) without Lender’s prior written consent, Lender may require immediate payment in full of all sums secured by this Security Instrument. However, this option shall not be exercised by Lender if such exercise is prohibited by Applicable Law.”

Given that lenders freely assign their mortgages to and from each other, and also sever the ownership of the note from the servicing rights, making it difficult for borrowers to keep track of or even know who their noteholder is, the fact that borrowers do not enjoy a similar ability to freely assign their ownership rights in the house seems unfair, particularly given that the lien would follow any assignment AND the borrower would remain personally liable for repayment of the debt. Regardless, due-on-sale clauses are generally enforceable. Fidelity Fed. Sav. & Loan Ass’n v. De la Cuesta, 458 U.S. 141, 159, 167, 102 S. Ct. 3014, 73 L. Ed. 2d 664 (1982).

Even if you cannot transfer your properties to your LLC without violating or potentially violating the due-on-sale clause, there exists a federal law that preempts all state laws, which allows you to transfer your property to a “inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupany in the property” without triggering the due-on-sale clause. 12 USCS § 1701j-3.

Consequently, the properties that you own outright or through non-FHA or conventional financing can go into your LLC while the rest should generally go into a family trust.

Please note that this article only contains rules of thumb. Every person’s situation is different and you should not take any action based on this blog post before consulting with a licensed attorney in your state with whom you have shared all relevant details of your assets, liabilities, and other factors.

Copyright 2017, Ian Ghrist, All Rights Reserved.

Disclaimer: This blog is for informational purposes only. Do not rely on any part of this blog as legal advice. Instead, seek out the advice of a licensed attorney.