Real estate investors and developers understand and embrace risk but do not always judge it well. When the market is hot, many developers, investors and owners sign personal guarantees. Now that the market is cooling off and may get further hammered by the rising interest rates of a possible recession, many are concerned about what will happen with the guarantees they signed. Will the lenders come to collect?
Yes, they almost certainly will, as we have seen in several past economic downturns. Lenders will sue for performance, use personal guarantees to obtain judgments and then use those judgments to collect against the personal assets of the debtors.
Our law firm has represented a multitude of clients over the years who have faced claims on their personal guarantees. These can be guarantees to lenders or to landlords, but they carry the same fear—will I lose my home and my life savings? Are my other investments in jeopardy?
For example, earlier this we represented Tom, a successful developer. Tom has completed several large projects across the country and has more than quadrupled his net worth since 2008. He has three projects nearing completion, but he is now uncertain whether the projects will be profitable. He is not even sure he will be able to finish construction, as he may lose financing before completion.
Tom would like to be able to walk away from these projects, if he must, but his personal guarantees total about $20 million. Tom’s assets include his homes in Los Angeles and Aspen, four apartment buildings in Texas and bank and brokerage accounts. He is in his early 60s, and he does not think he has enough time left to rebuild his fortune if he is wiped out by the personal guarantees.
Is it possible to protect Tom’s assets when he is already anticipating a default and is worried about his personal exposure? What about someone like Tom, where the loan or lease default has already taken place? The answer is yes, but with the caveat that there is no bullet-proof solution.
Asset protection is rarely about actually fully-protecting assets. We are not trying to make Tom’s assets unreachable, and that may not be in the cards in any case. We are looking to set up asset ownership structures that will make Tom’s assets more difficult and expensive to reach. That will change the lender’s economics and will make them more willing to settle with Tom.
In this case, Tom selected a combination of asset protection structures. An asset protection trust for his Los Angeles and Aspen homes, transferring the LLCs that own the Texas apartments into a Wyoming LLC partially owned by a separate asset protection trust and an offshore structure for the liquid assets, with some assets transferred to Europe and others remaining in the U.S. Tom also considered transferring some of the assets to his spouse, but we advised him against that. He should not be placing his spouse in the crosshairs of litigation.
With over 20 years of experience of setting up asset protection structures we can comfortably say that the lender will not take from Tom everything he has. They will choose to settle, and Tom will be happy with the settlement.
As the recession escalates, many more real estate developers and investors will find themselves in the same position as Tom. Asset protection may be their only hope of keeping the wealth they built, but they need to be realistic about what that actually means.
Jacob Stein is an asset protection attorney and the global chair of the private client practice at Aliant, LLP.