The seller in commercial real estate transactions is commonly a single-purpose LLC (limited liability company) set up to hold only one property. After the property is sold, the owners (members) of the LLC usually take the proceeds (via distribution from the LLC) and dissolve the LLC. Later when the buyer discovers a potential claim against the seller, say, for fraud and misrepresentation, the LLC has already been dissolved with no assets left.
Fraud and misrepresentation is probably the most common cause of action alleged by buyers against sellers in real estate transactions. In attempts to avoid such liability, sellers would typically include in the purchase and sale agreement (“PSA”) an “as is” clause stating that sellers make no representations (in some or all aspects) about the property, buyers are to rely solely on their own investigations, and buyers waive certain or all claims against sellers. Buyers who are not represented by legal counsel would tend to accept these as-is clauses as “standard”.
Contrary to popular misbelief, California, an “as is” clause in a PSA that requires a buyer to waive claims for fraud is unlawful and unenforceable. (See Civil Code 1668.) The court has repeatedly held that a seller (or landlord or broker) cannot absolve himself from liability for his own fraud by inserting exculpatory provisions in the contracts. See Wilson v. Rigali & Veselich (1934) 138 Cal. App. 760 (seller’s fraud), McClain v. Octagon Plaza, LLC (2008)159 Cal. App. 4th 784 (landlord’s fraud), Manderville v. PCG&S Group, Inc. (2007) 146 Cal. App. 4th 1486 (broker’s fraud).
So, how realistically can a buyer expect to recover damages for fraud in a real estate transaction against a seller LLC that is already dissolved?
In California, a creditor of a dissolved LLC may collect in any of the following ways: (1) against the dissolved LLC to the extent of its undistributed assets, or (2) against members of the dissolved LLC to the extent of the distributions received by the members upon dissolution. See California Corporations Code Section 17707.07(a)(1).
Note that, “dissolution” for purposes of this section includes “de facto dissolution” before a formal dissolution takes place (such as members’ vote to dissolve, a judicial decree, or the occurrence of a certain event set forth in the operating agreement or articles of organization). “De facto dissolution” can happen when an LLC stops operating its usual business (v. all business) with no intention to resume.
Take this 2014 case for example: A commercial real estate brokerage CBRE entered into an exclusive listing agreement with Jefferson 38 LLC (“Seller LLC”) to sell a 38-acre land in Murrieta, California. Somehow Seller LLC ended up selling its land to a buyer presented by another brokerage NAI Capital, which then received a commission of $354,000. After the sale closed, the proceeds were immediately distributed to the members of Seller LLC. Many months after that, Seller LLC filed a certificate of cancellation with the Secretary of State. Subsequently, CBRE filed a claim for breach of contract to get commissions against the dissolved Seller LLC.
In short, CBRE prevailed against the dissolved Seller LLC which had no assets left, and turned to sue the LLC members for the distribution of funds they received “upon dissolution”. The LLC members contended that the distribution was not made “upon dissolution” technically, because it was made “before” the LLC was formally dissolved by vote. Court of Appeal disagreed and held otherwise. CBRE was allowed to recover from the members. (See CBRE v. Terra Nostra Consultants (2014)230 Cal.App.4th 405.)
Note that this is not an alter ego or piercing the LLC veil case, and this case does not mean members of an LLC are personally liable for debts of the LLC. It just means that a creditor is allowed to recover against the LLC members to the extent of the money received as distributions upon dissolution.
In conclusion, when acquiring real estate from a single purpose LLC holding only one property, the buyer should engage the help of an attorney as early as possible. The high likelihood that shortly after the sale the seller will distribute all funds and dissolve is a risk factor that must be considered. There are important questions that an informed buyer should discuss early with legal counsel in a real estate transaction, such as:
- What information about the individual LLC members should be obtained during the transaction while the seller is still in the picture;
- What representations and warranties by the seller should be included in the PSA;
- To what extent can the buyer accept an as-is provision as customary or reasonable;
- What remedies could the buyer realistically expect to enforce against the seller after all is said and done, and, last but not least;
- How would the buyer collect damages if anything goes wrong but the seller is already dissolved.
This eBulletin was prepared by Monica Lin at CEO Law, Inc. (lin@CEOFirm.com).