November 12, 2014
There is a fairly customary practice in real estate development and construction intended to take advantage of the liability protections afforded by the Uniform Limited Liability Company Act. The practice is very straightforward:
- Operating Company, Inc. (OpCo), with ongoing day-to-day operations is engaged in the business of identifying, investigating, and developing real estate projects.
- When OpCo identifies a viable project (the “Project”), OpCo sets up a “single purpose entity” (“SPE”) to purchase and hold title to the real estate and contract for the improvements to the real estate. We’ll call this entity HoldCo, LLC.
- OpCo then sets up (or already has set up) a separate SPE to market and sell (or lease) portions of the Project. We’ll call this Sales, LLC.
- OpCo then sets up (or has already set up) a separate SPE to manage the Project after sale or lease. We’ll call this Management, LLC.
- In some instances, OpCo may have a controlling interest in or own a general contracting entity, Contractor, LLC, which contracts with HoldCo, LLC to construct the improvements to the Project.
We assume, for argument’s sake, that all of these LLC’s have been properly formed in accordance with State law and have been properly capitalized. All of these entities exist to capture the profits and fees from each stage of the development for the ultimate use of OpCo and its owners and investors.
STANDARD ENTITY LIABILITY MODEL
Traditionally, liability for different issues related to the Project rests with the entity responsible for that issue. The seller (HoldCo) gives with every deed a warranty of habitability that the buildings are free from defects and meet the accepted standards of design and construction. If HoldCo leases, then HoldCo carries the customary liabilities of a commercial landlord. Sales, LLC is responsible for any misrepresentations or other bad behavior in the marketing process. Management, LLC is responsible for any breaches of its duties to tenants or owners within the Project. Finally, Contractor, LLC is responsible for breach of its warranty of workmanlike service, negligence in the construction process, and resulting construction defects.
The liabilities are separate and distinct, and each party pays for its own sins. Because of the protections granted by the corporate form, the liability stops at the corporate (or LLC) level. In reliance on these principles, developers (and their lawyers) have assumed that the individual liability of one SPE cannot be transferred or shared with another SPE in the same development, and that the parent entity (HoldCo) and the affiliates (the other SPE’s) are protected.
HOW THE COURTS VIEW IT: AMALGAMATION OF INTERESTS
To quote the immortal words of Lee Corso, “Not so fast, my friend.” Enter the concept of “Amalgamation of Interests.” Under this concept, HoldCo and the individual SPE’s can be required to share liability arising from defective design and construction or other Project defects and harms. The concept creates liability among the entities where none was anticipated, without having to meet all the requirements of “piercing the corporate veil.”
The cases applying the “Amalgamation of Interests” tend to rely heavily of the facts of each particular situation. See, e.g., Juanita B. Kincaid and Beverly K. Davidson, a/k/a Beverly K. McLeod v. The Landing Development Corporation, Resort Management Group, Inc. and Resort Construction Corporation, 289 S.C. 89, 344 S.E.2d 869 (S.C. App. 1986); Mid-South Mgt. Co. Inc. v. Sherwood Development Corp., 374 S.C. 588, 649 S.E.2d 135 (S.C. App. 2007). However, some common themes run through the cases where the courts have found that interests are amalgamated, including the fact that HoldCo and all of the SPE’s share the same office, telephone numbers, board members, officers and employees.
WHAT DOES THIS MEAN FOR MY BUSINESS?
The use of multiple entities may make business sense and may be necessary for tax and lending considerations. Nothing in this discussion should suggest otherwise. However, having multiple entities that participate in the development process may create an opportunity for unexpected and unintended liability, and developers may put themselves in the crosshairs of an amalgamation claim by the manner in which they operate the various entities.
Developers may find it inconvenient or think it unnecessarily costly to maintain all of the separate entities, employees, and boards, but the Court can be quick to collapse all into one and defeat the intentions of the initial planning. Developers need to understand the operational risks that defeat the initial legal structure, and the importance of maintaining the distinctions created.
Attorneys Brian Autry and Henry Brown represent businesses and professionals in various legal matters related to construction litigation and transactions. For more information or to discuss your specific situation, feel free to contact them at firstname.lastname@example.org or email@example.com.