Thursday, September 20, 2007

Exceptions to Limited Liability

Last week I noted the story and decision of City of Springfield Code Enforcement v. Concerned Citizens for Springfield, Inc., et al. in which Housing Court Judge William H. Abrashkin ordered the individual manager (Shalom Segelman) of the property owning limited liability company to pay $1.3 million in relocation costs for the tenants in the sub-standard apartment complex.

After reviewing the case, it is not clear whether the judge was piercing the liability shield of the LLC or carving an exception to the liability shield.

M.G.L. C. 156C s. 22 provides that no ". . . member or manager of a limited liability company shall be personally liable, directly or indirectly, including, without limitation, by way of indemnification, contribution, assessment or otherwise, for any such debt, obligation or liability of the limited liability company solely by reason of being a member or acting as a manager of the limited liability company." This is the liability shield for a limited liability company.

Judge Abrashkin looks to the definition of owner under the State Sanitary Code (105 CMR 400) that imposes obligations on the owner. The code has a very broad definition of owner:

"Owner means every person who alone or severally with others:
(1) has legal title to any dwelling, dwelling unit, mobile dwelling unit, or parcel of land,vacant or otherwise, including a mobile home park; or
(2) has care, charge or control of any dwelling, dwelling unit, mobile dwelling unit or parcel of land, vacant or otherwise, including a mobile home park, in any capacity including but not limited to agent, executor, executrix, administrator, administratrix, trustee or guardian of the estate of the holder of legal title; or
(3) is a mortgagee in possession of any such property; or
(4) is an agent, trustee or other person appointed by the courts and vested with possession or control of any such property; or
(5) is an officer or trustee of the association of unit owners of a condominium.

Each such person is bound to comply with the provisions of these minimum standards as if he were the owner. Owner also means every person who operates a rooming house."
My reading of Judge Abrashkin's decision is that this definition of owner is an exception to the liability shield of M.G.L. C. 156C s. 22.

I disagree with a statement in the Judge's analysis: "Had this complex gone in the other direction Mr. Segelman would, rightly, have insisted upon reaping the rewards. With the benefits go the burden, and this one falls unavoidably, upon Mr. Segelman."

One the basic paradigm's of investing in real estate (and any business) is being able to limit your losses. If I went out and bought a share of Boston Properties, Inc. (BXP) I would pay the $104.37 that it costs (as of this morning). I have unlimited upside. The stock could triple in value and pay out enormous dividends. My downside is limited to the $104.37 that I paid for the share. As a shareholder, I would never expect to get a bill to contribute more capital to Boston Properties because one of their buildings is in disrepair.

I expect the same treatment if I were an individual investor in a limited liability company that directly owned an apartment building. I know my initial capital is at risk, but I should not have to put additional capital in (unless I agreed to under the limited liability company agreement). I could lose all of my investment. But I should not have to lose more than my investment.

That being said, there are some exceptions to this liability shield. In real estate, there is CERCLA's ability to look through entity for liability due to environmental contamination. (You can read this article by Daniel M. Darragh of Buchanan Ingersoll & Rooney PC on Indirect Owner/Operator Liability Under CERCLA). There is also the equitable remedy of piercing the corporate veil.

In his order, Judge Abrashkin did not discuss any of the factors for piercing the corporate veil. So I am left to assume that the Massachusetts state sanitary code is an exception to the limited liability of an entity.

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