Freddy Stein is an active real estate flipper making big moves in the Atlanta market. He currently has four properties he’s rehabilitating, all held under his corporation. Bad idea! We always recommend that our clients hold each property in a separate LLC to insulate them from each other. The way Freddy’s business was set up, a lawsuit could wipe out all his investments in one fell swoop. Apparently, his quack of an attorney had advised him not to complicate his business structure. The attorney argued that:
- The additional expense of creating the LLCs was unnecessary.
- The LLCs will each need a separate bank account.
- The LLCs will need separate accounting.
It was bad enough that the attorney did not understand the basics of asset protection. Worse yet, he did not understand investing. Freddy was using money from private investors to finance his deals. This meant that if Freddy’s business got involved in a lawsuit and lost, there was a chance of losing all his property and the investors’ money. This would then lead to each of his investors suing him for the lost money. Common situations like this are why any real estate should consider using separate LLCs when dealing with joint ventures. And yes, there’s more. There are even greater risks lying in wait for Freddy and other joint venture investors.
Liability Risks Associated with Joint Ventures
When you enter into any type of joint venture with a third party, you are basically in a partnership. For this reason, you have duties regarding how you treat your JV partner(s). A breach of any of these duties can result in liability for you and your business.
Good Faith and Fair Dealing
This obligation begins with the joint venture offer to third parties. It continues throughout the agreement until the property is sold.
Loyalty to Joint Venture Partners
You must always place the business or personal interests of your joint venture partners above your own. You must steer clear of situations that might cause a conflict of interest or self-dealing for your personal gain. In a business such as Freddy’s, it is very easy to fall into conflict of interest traps. One of the partners could claim Freddy never devoted his best efforts to their deal because other joint venture deals under the same company were more lucrative. While he could argue that he’d never do such a thing, the investor’s perception alone can motivate a lawsuit.
Freddy could point out that he did not disclose his other joint venture arrangements with his investors. This is a breach in itself because he did not disclose relevant information to the other partners.
Duty of Care
This requires that you act reasonably, in good faith, and without conflict of interest when making decisions for the business. For Freddy, there is a glaring conflict of interest when he’s trying to manage three joint ventures concurrently. In his current arrangement, he is managing all his joint venture contributions, income from the sale of property, and property expenses via one bank account. Liabilities may arise regarding the use of the joint venture funds for other investors and personal benefit to Freddy.
The truth is, lawsuits are not exclusively centered around issues related to business assets. They can also be fueled by how a business is run. Freddy’s business is currently a legal disaster waiting to happen. Joint venture investors like Freddy should structure their businesses inside LLCs instead. Doing this can limit these liability risks and prevent potentially ruinous lawsuits.