I Want the Protection of an LLC: What About the Due on Sale Clause?

I just purchased an investment property, but my mortgage documents say that the lender can require me to pay the entire amount owed if I transfer my interest in the property to a business entity that protects me from personal liability.

However, I am not comfortable leaving the property in my personal name. What happens if, heaven forbid, a tenant is killed in the property, or their dog bites a neighbor child, or some other damages are assigned to me because the property is in my own name? Even with my best efforts, such liability cannot be completely planned for or avoided. What should I do?

This thought process is common to our investor clients and these questions are commonly asked. Fortunately, we are frequently able to help alleviate their concerns.

Lenders Won’t Call in Your Note

We often hear people say that there is no reason to be worried because a lender is not going to call in your note. As long as you keep paying the mortgage, the lender doesn’t care whether you transfer the property into an LLC for liability protection. In the spirit of full disclosure, this thought process is not far off from practical reality.

Lenders primarily care about getting paid. Your personal guarantee does not get eliminated when you transfer a property into a business entity, and their interest in the property continues to have priority over other, later-recorded interests.

But Can Lenders Call in My Note?

However, it causes many investors significant discomfort in knowing that a lender may have legal grounds to call in their note(s). Fortunately, HUD has stepped in to say that a properly executed transfer into an appropriate business entity is exempt from exercising a due on sale clause in most instances.

What is an Appropriate Business Entity?

What qualifies as an appropriate business entity? I am glad you asked. HUD has stated that transferring real property into an LLC is exempt from a lender exercising a due on sale clause provided that the borrower is a majority member of a member-managed LLC for certain types of mortgages. Admittedly, this statement requires some unpacking that will likely be best addressed in a consultation.

Can I Protect My Investment and Avoid the Due on Sale Clause?

Please feel free to contact Stout Law to set up a complimentary consultation to learn more about how to avoid the due on sale clause, what mortgages are exempt, how to set up the correct business entity, how to properly transfer the property into the correct business entity, and how to execute an operating agreement to meet the requirements specified by HUD.

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