Passing Along Good Advice to Small Business Owners

I. PASSING ALONG GOOD ADVICE

In our continuing effort to keep our clients (and us) well informed we read lots of legal periodicals and articles from a variety of sources. Recently I came across an article entitled “Top Ten Legal Mistakes That Can Sink Your Landlord Business” and thought it would be helpful to comment on some of the topics raised.

LEASES

I’m surprised to learn of the number of landlords who do not have a written lease or rental agreement, or allow an initial lease to expire and make no or little effort to document their continuing and sometimes modified landlord/tenant relationship. Although most landlords know it’s important to have a written lease or rental agreement, many use the so called “standard” forms that are sold but probably not compliant with the laws of New Jersey. Using “stationary store leases” could result in you being at the loosing end of a lawsuit because of an unenforceable clause in the lease. Some of these leases also impose greater obligations or restrictions on you or the tenant than New Jersey allows.


CHARGING EXCESSIVE LATE FEES

Late fees can be a powerful tool to motivate tenants to pay rent on time.


While a higher fee can be a better motivator, some landlords cross the line, by setting fees that bear little resemblance to the actual damages they suffer when tenants pay late. Courts are increasingly in validating excessive late fees that can’t be justified with hard evidence. You’re better off setting a modest fee that reflects your true damages, and dealing with chronic late-payers with pay-or-quit notices.


USING SECURITY DEPOSITS FOR THE WRONG PROJECTS

The most frequent types of case hear in Small Claims Court are arguments over security deposit retention. Yet the basic rule—that deposit should be used only to cover damage beyond wear and tear, needed cleaning and unpaid rent—isn’t hard to understand. Still, landlords routinely use the deposit to cover appliance upgrades, cosmetic improvements and other refurbishing, not repairs. Not surprisingly many of these landlords loose these cases in Small Claims Court.


KEEPING SECURITY DEPOSITS WHEN TENANTS BREAK THE LEASE

When tenants break the lease and leave early, landlords often keep the entire deposit, reasoning that the tenant’s bad behavior justifies doing so, and that they’ll ultimately need it anyway to cover rent. In many states this is illegal—you must take reasonably prompt steps to re-rent, and credit any new rent toward the tenant’s obligation for the rest of the lease.


FAILING TO RETURN SECURITY DEPOSITS ACCORDING TO THE LAW

Many states have deadlines by which landlords must itemize their use of the deposit and return any balance. It’s not uncommon for tenants to wait many weeks or months for this accounting. In some states, the deliberate or “bad faith” retention of the deposit will result in harsh penalties against the landlord, such as an order that the landlord pay two or three times the deposit to the tenant.


IGNORING DANGEROUS CONDITIONS IN OR AROUND THE RENTAL

Landlords in virtually every state are required to offer and maintain housing that meets basic health and safety standards, such as those set by State and Local Building Codes, Health Ordinances and Landlord/Tenant Laws. If you fail to take care of important repairs, deal with environmental hazards, or respond when your property has become an easy mark for criminals, tenants may break the lease and, in many states, withhold the rent or make the repair themselves and deduct the expense from the rent. Landlords who have failed to make their properties reasonably secure in the face of repeated onsite crime are often ordered to compensate the tenant-victim when yet another criminal intrudes. These are expensive ways to learn the law.


II. THE USE OF LIMITED LIABILITY COMPANIES IN HOLDING REAL PROPERTY

The operating assets of a business should often be owned separately from business real estate for liability purposes. The use of an LLC to hold title to the real estate protects the real estate from liabilities arising from the operations of the business. An LLC is not subject to the same statutory requirements as a corporation with respect to formalities such as having annual meetings, minutes, etc. Also the tax treatment of an LLC may be preferred over the tax treatment of a corporation used for the same purpose (you should consult your accountant or other financial advisors with respect to this tax issue).

The fundamental characteristic of an LLC is that affords its members protection from the liabilities arising at the company level in comparison to a corporation. The ownership of real estate inherently involves the undertaking of several potential risks, such as risk of liability for adverse environmental conditions and liability for personal injuries and property damage occurring as a result of dangerous conditions on the real estate. The LLC ownership structure may be the best vehicle for holding title to the real estate in a manner that allows the owners to be protected from the risks and liabilities arising in connection with the real estate.

Another benefit that may be afforded by a multi-member LLC structure is the ability to impose restrictions in the LLC Operating Agreement, which may prohibit a creditor from acquiring a membership interest of a member and participating in the operations of the LLC. Protecting the LLC from creditor control requires a properly crafted Operating Agreement which includes, for example, a provision giving other members and the LLC the right to purchase the member’s interest in the event that an assignment for the benefit of creditors is awarded against one member. There are many other ways to achieve this goal. Consulting experienced legal counsel is a good first step.

-Dan Posternock


***The information included in this newsletter is not, nor is it intended to be, legal advice. You should consult an attorney for advice regarding your individual situation. We invite you to contact us and welcome your calls, letters and electronic mail. Contacting us does not create an attorney-client relationship. Please do not send any confidential information to us until such time as an attorney-client relationship has been established.