Unburdening Company Myths #1 and #2

Unburdening Company Myth # 1 – If you deploy a transfer policy you are guilty of unreasonable restraint of alienation.

Unburdening Company Myth # 2 –It is perfectly legal to transfer a timeshare interest to a LLC.

This is legal speak mumbled by the Unburdening Companies and their attorneys.

In theory, if timeshare estates were truly absolute fee simple estates, it might be argued that the conveyances arranged by the unburdening companies are legal. Timeshare estates are certainly far less than absolute fee simple estates; being created from the governing documents to which they are subject, further subject to specific regulatory control, held typically in tenancy in common with thousands of other owners and are severely restricted as to use rights. All of these aspects, especially the terms of the governing documents, are already recognized as reasonable restraints of alienation.

In theory, LLC’s, trusts, and corporations are legal entities that can own real estate. In reality there is entire body of Federal and State case law and legislation that places substantial requirements on how such entities behave in order to legally enforce their rights.

A practical examination of the actual conveyance transactions created by the unburdening companies provides ample legal basis for associations to reasonably control and, where conditions determined from factual publicly derived evidence dictate, reject these transfers.

The following is an analysis as to the legal basis upon which the Associations can deploy proper estoppel and conveyance practices and procedures.

1. Analysis of the LLC’s and other Business Entities (“LLC”).Standing/Authority of an LLC to transact business in the Situs State. In order for an LLC to enforce any claims it has in court, it must establish standing/authority to sue.1 To have standing in a particular state, the LLC must be registered in order to transact business in that state and do such things as are necessary to remain in good standing in that state (e.g., file an annual report and pay taxes).2 In some cases, courts have dismissed lawsuits where a company has failed to file an annual report.3 Additionally, failure to pay taxes will result in the company lacking good standing and therefore lacking capacity to sue.4 Therefore, to ensure that the LLC can enforce any claims it has in court, it should be registered to transact business in all states where it would potentially need to enforce such claims and should comply with all statutory requirements (e.g., filing annual reports and paying taxes).5

Universally, timeshare Associations, by virtue of their recorded declaration, hold a continuing lien for assessments and are granted broad powers, including but not limited to the power of sale, for their collection. In fact, any conveyance of a timeshare interest is subject to the governing documents. Therefore,

    1. TTR asserts that an Association is entitled to be provided a legal physical address of the proposed transferee for the purpose of process service. An examination of the registrations of the majority of the LLCs (and individuals) show addresses of P.O. Boxes, virtual offices, corporation filing services, and in some cases, fictional addresses that would be inadequate for process service. Therefore, an Association requiring a physical address for process service of at least the manager of an LLC prior to conveyance, would not be an unreasonable restraint of alienation.
    2. By virtue of the continuing lien for Assessments, upon the conveyance of a timeshare estate there is an express contract created within the governing documents between the Member of the Association and the Association to pay Assessments.  This contract occurs within the Situs State of the resort which further enforces the necessity of an LLC taking title to a timeshare estate to be registered to do business within that State. Therefore, it would not be an unreasonable restraint of alienation for an Association to require such registration of an LLC before allowing a conveyance.
    3. TTR further believes that the LLC, by owning real property in a particular state, is transacting business in that state, and therefore must be registered in that state.
    4. In addition, depending on a particular State’s regulation of escrow agents, the escrow company processing an “escrow” may be required to be licensed under that State’s appropriate regulatory agency.

2. Power of Attorney. To be effective, a limited Power of Attorney must legally and correctly identify the grantors and the attorney, and their capacities. If the power is granted to transact business regarding a specific real property interest, then an adequate legal description of that real property must be included.  The Power of Attorney can only be exercised by the person or entity that has been granted that power.

A practical examination of the Power of Attorneys utilized by the unburdening companies usually reveals some defect in the form and content. Of the hundreds of such documents TTR has reviewed, very few are not without defect and, almost without exception the powers granted are exercised by someone other than the named attorney. The instructions accompanying the Power of Attorney are submitted by the escrow company and not by the attorney itself.  Usually, the grantors legal capacity is not correctly reflected and or the real property is not adequately identified.

Therefore prior to acting on any instructions, an Association requiring a correction of the defects within the power of attorney, or requiring the instructions accompanying it, be submitted by the actual attorney and be notarized, would not be an unreasonable restraint of alienation.

 3. Limited Liability of Members and Managers; Personal Liability under Agency or Other Law.  A member of an LLC who personally participates in tortious conduct (bad acts) of the company may be held personally liable for the consequences of their conduct. 6 Members or managers may be personally liable if they, in their individual capacity, damage someone else’s contractual or business relationships.7 An agent or officer who participates in the commission of a tort is liable whether or not he is acting on behalf of another or the LLC.8 Even if officers and agents of the company are not participating “hands on” at every step, they may be held personally liable for violations.9 This liability is not based solely on their membership in the LLC. Rather, it is the fact that they are present and participating in the operations of the company while a violation is being committed (either by them or the company) that incurs the liability.10

Based on the above, it is TTR’s position that to knowingly and intentionally transfer a real property interest that carries an assessment liability to an insolvent LLC (regardless of its legal status at the time of conveyance) is fraud and concealment. Further, the intentional default by such an entity on assessment obligations damages all of the contractual relationships of the other (tenants in common) members of the Association.

4, Alter Ego Theory – Piercing the Veil. Another approach to piercing the veil is the “alter ego” theory. This has been adopted by many states and occurs where a corporation (or LLC) is deemed merely a front for another entity. Delaware courts,  adhere to the “instrumentality” theory of veil piercing, and thus have not expressly adopted the alter ego theory. However, one of the most authoritative passages on the alter ego theory was written by a Delaware judge applying a federal standard. She wrote that the alter ego analysis:

“includes whether the corporation was adequately [funded] for the corporate undertaking; whether the corporation was solvent; whether dividends were paid, corporate records kept, officers and directors functioned properly and other corporate formalities were observed; whether the dominant shareholder siphoned corporate funds; and whether, in general, the corporation simply functioned as a façade for the dominant shareholder … [N]o single factor could justify a decision to disregard the corporate entity, but that some combination of them was required and that an overall element of injustice or unfairness must always be present, as well.11″

Although Delaware Courts have not expressly adopted the alter ego theory, courts in other states have applied it to Delaware companies in actions pending in their jurisdictions. New York has adopted the alter ego theory. To establish alter ego liability, New York courts require evidence of 1) a single economic unit and 2) injustice.12

 Some factors a court will consider in determining whether to pierce the veil, whether according to an instrumentality or alter ego theory, are:

  1. Significant lack of funding for the LLC (requirements vary based on industry, location and specific circumstances);
  2. Failure to observe formalities in terms of behavior and documentation (regularly scheduled meetings, keeping notes of the meetings, recording votes, etc.);
  3. Failure to pay dividends/distributions;
  4. Non-functioning officers and/or directors;
  5. Concealment or misrepresentation of members;
  6. Absence or inaccuracy of financial records;
  7. Use of the LLC as a front for personal business of the dominant member(s) (alter ego theory);
  8. Failure to maintain arm’s length relationships with related entities; or
  9. Manipulation of assets or liabilities to concentrate those assets or liabilities.

This list is not exhaustive, but is intended to give a general idea of the types of things typical to the conveyance to shell LLCs. Not all factors have to be met and usually satisfaction of only one factor is not enough to pierce the veil, but this will depend on the circumstances and egregiousness of the conduct.

 Clearly, most of the conditions cited above exist in the case of the conveyances of timeshare interests by the unburdening companies to the shell entities that they created.  Therefore, prior to accepting a conveyance to an LLC or an individual, an Association requiring documentation or explanation in the event of the above conditions, would not be an unreasonable restraint of alienation.

5. Solvency. Under the Bankruptcy Code –  U.S. Code Title 11 › Chapter 1 › § 101 (32) The term “insolvent” means with reference to an entity other than a partnership and a municipality, financial condition such that the sum of such entity’s debts is greater than all of such entity’s property, at a fair valuation. TTR Classifies individuals or entities as asset-less, when public records show an unusually high number of timeshare intervals being conveyed to them or have received verified reports from subscribers that they have already defaulted on assessments or have never paid them after been conveyed.

TTR asserts that it is not an unreasonable restraint of alienation to require a transferee so classified to provide an explanation of the number of timeshare estates it has taken title to and to provide evidence that the transferee has the liquidity sufficient to pay the assessments.

6. Model Language. TTR recommends an Association adopt into its governing documents, typically in the Rules and Regulations, or at least adopt a transfer policy similar to this model:

Not later than (30) days before the voluntary or involuntary sale, transfer or assignment of any Vacation Ownership, Timeshare Interval or Timeshare Estate the current Member shall notify the Association in writing. The current Member or their authorized escrow agent shall submit a Standardized Vacation Ownership Estoppel request, a Company Resolution from the proposed transferee (if a Corporation, Trust or Company), a Membership Application from the proposed transferee and a pro forma of the conveyance document prior to its recordation. In the absence of such notice and required documentation, and prior to the Association’s approval of the recordation of the conveyance documents, the Association shall not be required to recognize the transferee for any purpose. Any action taken, prior to the giving of such notice and required documentation by the transferor, as an Owner, shall be recognized by the Association. Prior to receipt of any such notification and documentation by the Association, any and all communications required or permitted to be given by the Association shall be given to the Owner.

TTR asserts that it is not an unreasonable restraint of alienation to require a transferor to comply with this policy.

6. Pro forma Conveyance Documents. By far, the most commonly recorded conveyance document used by the transfer agent is a quit claim deed. These deeds, executed by the named attorney, typically lack a proper legal description, correct interval number, Assessor’s Parcel Number, or correct vesting language for the grantor. The recordation of the defective deed creates a bifurcation of title between the Recorder’s office and the Assessor’s office.

TTR asserts that it is not an unreasonable restraint of alienation to require a transferor submit pro forma conveyance documents prior to recordation to prevent such clouds on the title of the timeshare estate being conveyed

1.Morgan Howard (United States), LLC v. Lewis, No. FSTCV 054006343S, 2006 WL 2348892, at *2 (Conn. Super. July 14, 2006); See also, Zahrijczuk v. Branford Water Pollution Control Auth., No. CV116024727, 2012 WL 1511369, at *2 (Conn. Super. Apr. 10, 2012) (quoting Cmty. Brd. 7 v. Schaffer, 639 N.E.2d 1, 4 (N.Y. 1994)) (“Business corporations . . . are creatures of statute and, as such, require statutory authority to sue and be sued[.]”).

2.Id.

3.SMLL, LLC v. Daly, 128 P.3d 266, 266 (Colo. App. June16, 2005).

4.Real Estate Network, LLC v. Gateway Ventures, LLC, No. 4:05-CV-422-CAS, 2005 WL 1668194, at *3 (E.D. Mo. July 12, 2005); See also, N.Y. Bus. Corp. Law § 1312(a) (“A foreign corporation doing business in this state without authority shall not maintain any action or special proceeding in this state unless and until such corporation has been authorized to do business in this state and it has paid to the state all fees and taxes imposed under the tax law or any related statute[.]”).

5.Id. at *2; HMMH Holdings, LLC v. Hallenborg, No. CV065001446S, 2006 WL 2411476, at *1 (Conn. Super. Aug. 1, 2006); Eschelon Photography, LLC v. Dara Partners, L.P., No. 99968/05, 11 Misc.3d 1064(A), at *8 (N.Y. City Civ. Ct. Jan. 25, 2006).

6.McFarland v. Virginia Ret. Servs. Of Chesterfield, LLC, 477 F.Supp.2d 727, 740 (E.D.Va. 2007).

7.Brew City Redevelopment Grp., LLC v. Ferchill Grp., 297 Wis.2d 606, 626 (2006).

8.Ventres v. Goodspeed Airport, LLC, 275 Conn. 105, 142 (2005).

9. MaryCLE, LLC v. First Choice Internet, Inc., 166. Md.App. 481, 530 (2006).

10.Estate of Sestito v. Silk, LLC, No. X04CV010103522S, 2004 WL 574517, at *3 (Conn. Super. Mar. 9, 2004).

11.Harco Nat. Ins. Co. v. Green Farms, Inc., CIV. A. No. 1131, 1989 WL 110537, at *1039-40 (Del. Ch. Sept. 19, 1989).

12. NetJets Aviation, Inc. v. LHC Commc’ns, LLC, 537 F.3d 168, 176 (2d Cir. 2008).