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By Melissa Matheson
- You can’t do a criminal background check on a tenant!
- You must rent out your property or pay a fine!
- You must report all of your company’s beneficial owners!
Do these exclamations ring of an authoritarian bureaucracy? That bell is ringing louder in the last year as local, state and federal agencies have approved new restrictions on property and privacy rights.
In California, the Oakland City Council outlawed criminal background checks on prospective tenants. The stated purpose is to allow the formerly incarcerated to compete for housing and avoid homelessness.
Any housing provider and any person aiding a housing provider (i.e. a management company) face stiff penalties for doing a criminal check. Liability can be three times the greater of a) one month’s rent or b) actual damages, including damages for mental or emotional distress. A court may award punitive damages and attorney’s fees. Criminal penalties may also be asserted. Tenant’s rights attorneys could make hay with this ordinance.
If you own a rental property in Oakland you most certainly want it titled in the name of an LLC, shielding yourself from personal liability. And rather than screening tenants personally (for which the high penalties again apply) you will want to use an independent management company for that task. If there is an accidental criminal background check on a prospective Oakland tenant, the management company will suffer the consequences, not you.
But while the new law allows criminal offenders to rent in Oakland, it doesn’t change a duty that is required across the Country. Landlords have a duty to protect the neighborhood of the rental property from the criminal acts of their tenants. Landlords are routinely held responsible for their tenants dealing drugs on the property. Other tenants, or anyone in the neighborhood, can sue the landlord for the rental property being a public nuisance that threatens public safety.
So in Oakland you have to rent to criminals but you are still responsible if they engage in crime. If one of your investing guidelines is to avoid nonsensical Catch-22s, you may want to sell your Oakland properties and never invest there again. Please note that several other cities in the San Francisco Bay Area are also considering legislation to ban criminal background checks. Accordingly, you may need to reinvest farther away.
Across the Bay, San Francisco voters just approved two measures affecting real estate rights. The first one aims to deal with the “blight” of empty storefronts. The owners of retail spaces remaining vacant for six months or more will now pay a tax of $250 per foot of linear frontage. The tax can rise to $1,000 a foot in later years. New York City is considering a similar tax.
Supporters claim landlords don’t care about local neighborhoods and only want more rent. (Of course, leaving a storefront vacant for years does not really constitute more rent). Opponents argue the measure ignores current realities. San Francisco’s permitting process for tenant improvements and alterations, as well as new business approvals, is notoriously byzantine and can take a year or more to complete. Bank financing requirements for expensive neighborhood retail spaces feature covenants calling for only the most credit worthy tenants, limiting the pool of prospective users. And, the rise of e-commerce has certainly not benefitted anyone in the brick and mortar space. The unintended consequences of this ordinance will be interesting to watch from a distance.
San Francisco voters also passed a measure tying office development permits to affordable housing goals. The city builds an average of 712 affordable housing units per year. The new law asserts that 2,042 units must be built every year and if not the annual 875,000 square feet allocated for office uses must be reduced accordingly. So if 1,024 affordable housing units are built (which never happens) then using the same 50% figure only 437,500 square feet of office space can be approved.
San Francisco’s chief economist wrote:
“By tying future office development to an affordable housing target that the city has never met, the…measure is likely to lead to high office rents, reduced tax revenue, reduced incomes and reduced employment across the city’s economy.”
But that didn’t stop San Francisco’s voters. It is indubitable that Adam Smith is not taught in their schools. The invisible hand, as put forth by Adam Smith’s “The Wealth of Nations” in 1776, describes the unintended social benefits of an individual’s self-interested actions. If the market needs affordable housing and the government gets out of the way, affordable housing will be built. But government in San Francisco and in California are in the way. Some find it very easy to dismiss the ancient teachings of Adam Smith, but in doing so they never fully and critically examine why affordable housing is not being built. Virtue signaling is so much easier. It is certain that this new measure will only further clog the natural arteries of commerce.
The state of California has also inserted their own very visible hand into the real estate market. State wide rent control has arrived.
• Properties older than 15 years are limited to annual rent increases of 5% plus an inflation rate or 10%, whichever is less. Owners cannot raise the rent above the new limits to cover capital improvements on these older buildings, which means the Golden State will now shine with deferred maintenance.
• The new California law also restricts landlords’ ability to evict tenants. If a tenant has occupied a unit for at least 12 months evictions can be for “just causes” (where the tenant is at fault) and a limited number of cases where they are not at fault (such as the owner moving in or taking the unit off the market).
• When evicting any tenant a landlord must now provide written notice and state whether it is an at fault or no fault issue. If there is no fault on the tenant’s part, the landlord must provide one month’s rent money to cover the tenant’s relocation expenses.
Will even more people reinvest further away from California?
No matter where you invest it is important to take title to real estate in the name of a limited liability company (or LLC). As I wrote in my book “Loopholes of Real Estate” there are too many legal loopholes allowing tenants and others to sue property owners. You can close that loophole of unlimited personal liability by holding real estate title(s) in one or more LLCs.
We always recommend taking title in an LLC or, in some cases, a limited partnership (LP). But the two main benefits of forming such entities, limited liability and privacy, are under attack by certain governments.
The attacks come under the nobility of expanding virtue and punishing evil. Who can argue that employees shouldn’t be paid what they are owed? Of course they should. But this must be balanced so that employers want to hire workers.
California and New York now hold corporate owners responsible for wage and hour law violations. In California, corporate officers and managers can now be held personally liable for civil penalties resulting from minimum wage violations. Personal liability gets your attention. Either the company follows the rules or, with personal liability hanging over your head, you quit.
New York has gone even further. And in further we mean it has upset the balance between productive employment and limited liability protection. The top ten owners of an LLC can now be held personally responsible for violating New York’s wage and hour laws.
Consider the following example: You invest $10,000 into an LLC doing business in New York. In exchange, you receive a 1% interest in the LLC. Nine other investors hold the remaining 99% and three of them conduct the LLC’s business operations. You are a passive investor with no management control or authority. You like it that way. You invested into a limited liability company because your liability is limited to the $10,000 you invested, and nothing more.
But New York has now changed the rules. If the three managers don’t pay, for example, $100,000 in wages, you are now on the hook for the payment. Even though you only own 1% of the LLC and had no management authority you are now ‘jointly and severally’ liable for the money. This means that if the other nine owners flee, or are bankrupt, you now owe the entire wage claim amount. What if people turn in their shares and all of a sudden, without your knowledge, you are a top ten owner? You are responsible for the whole claim.
New York’s law totally upends the concept of limited liability. Attorneys will be counseling clients to think long and hard about doing business in New York. Mind you, all this disruption is in the name of protecting workers.
The District of Columbia is also demanding more from LLCs. Their government, with the stated virtuous goal to “expose bad landlord(s) hiding behind an LLC”, now wants ownership information on all LLCs (whether for real estate or business) formed in D.C. or doing business in the District.
Now, in all filings, the name, state of residence and business address of every person with either a 10% or greater ownership in the LLC, or who controls day to day operations of the entity, must be provided.
It is not hard to visualize the next step from this collection of information. Plaintiff’s attorneys will be suing not only the LLC, but also the LLC’s individual owners. In some cases, the courts will dismiss any personal claims when the liability rests with the LLC. But in many cases the suing of individuals will be used to gain leverage in the litigation. And again, the limited liability protection of the LLC will be diminished through government regulation.
At the federal level, the U.S. House of Representatives recently passed the Corporate Transparency Act of 2019. The bill, which requires the disclosure of beneficial owners of corporations and LLCs, is now before the Senate. If enacted, every entity filing under “the laws of a state or Indian Tribe” shall file a report with FinCEN containing the name, date of birth, address and passport or personal ID number of every beneficial owner.
FinCEN stands for the U.S. Treasury’s Financial Crimes Enforcement Network. Founded in 1990 and broadened under the Patriot Act in 2002, the agency tracks suspicious currency activities and other illicit financial activities.
Congress justifies the need for beneficial ownership information under the following finding:
“Criminals have exploited State formation procedures to conceal their identities when forming corporations or limited liability companies in the United States, and have then used the newly created entities to commit crimes affecting interstate and international commerce such as terrorism, proliferation financing, drug and human trafficking, money laundering, tax evasion, counterfeiting, piracy, securities fraud, financial fraud, and acts of foreign corruption.”
If the Senate passes it, the bill would also require entities to file an annual report containing the current owners and any changes in beneficial owners during the previous year. As well, the law would prohibit the issuance of bearer shares, whereby the owner is not identified as a shareholder on a share or membership certificate.
The act defines beneficial owner as a natural person who directly or indirectly owns 25% or more of the entity’s equity, or who exercises substantial control or who receives substantial economic benefits from the entity. As to the last standard, the Treasury Secretary gets to determine what percentage of ownership equates to substantial benefit. Conceivably, every entity owner, no matter how small their ownership, could be required to disclose their personal information.
Would criminals provide false beneficial ownership information anyway? Perhaps. The penalty for doing so is a fine of up to $10,000 and prison time of up to three years. But an offshore straw man with no U.S. contacts could certainly, for the right price, put forward their passport and personal information for the benefit of a real bad guy.
Of course, as a consequence of trying to catch some criminals, every single American business, every single entrepreneur and real estate investor using a corporation or LLC, millions and millions of them, must now file initial and annual reports – forever!
• Can FinCEN handle that much reporting?
• Can they handle the responsibility to keep all that information private?
• Should you ask your U.S. Senate candidates if they support this bill?
The Electronic Frontier Foundation in San Francisco has questioned the benefits of FinCEN compared to the loss of individual privacy. They question the effectiveness of FinCEN’s “Suspicious Activity Reports”, and why no studies have identified how many reports are filed on innocent people. If the Senate passes the Corporate Transparency Act of 2019, the Foundation’s long-time concerns of Fourth Amendment protections against unreasonable searches and seizures will come again to the fore. Any government investigator will be able to use FinCEN’s database to investigate people instead of crimes.
Governments offer less protection and want more information about LLCs and corporations. Where does it lead?