Investing in rental properties has tax and wealth building advantages. Like any other business, mitigating risk is necessary to protect your assets. Oftentimes, individuals believe that forming an entity is enough to protect oneself from legal liability. This is far from the truth. Landlords get sued for various reasons such as poorly maintained property, unpaid mortgages, liens against the property, dispute of landlord responsibilities, the list goes on and on.
To increase asset protection, consider using a multi layer barrier approach that impedes possible claimants from future lawsuits. While this may not be 100% legal liability proof, you’ll greatly reduce your chances. Additionally, insurance companies and entities may not protect landlords who are proven negligent, grossly negligent by acts or omissions, or determined to violate the law.
Below are 8 layers of asset protection.
Have the Property Under an Entity
When an entity is created, it becomes separate from its owner which reduces liability for the landlord.
Landlords can form a corporation or a limited liability company (LLC). LLCs are more common for their flexibility. Learn more about LLC formations here.
Be wary of the corporate veil. Piercing the corporate veil is an equitable remedy under Texas Business Code Section 101 when owners/landlords commingle funds (personal funds are mixed with company funds), do not treat the company as a separate business entity, use the company to commit illegal acts such as actual fraud, personal guarantees, diversion of company profits for individual personal use, inadequate capital, failure of proper legal documents.
Under Texas Business Code Section 101.114, exceptions to piercing the corporate veil states: “Except as and to the extent the company agreement specifically provides otherwise, a member or manager is not liable for a debt, obligation, or liability of a limited liability company, including a debt, obligation, or liability under a judgment, decree, or order of a court.”
According to Castleberry v. Branscum Texas Supreme Court established the veil piercing doctrine stating that entities usually protect shareholders, officers, and directors from company liabilities, however if those individuals abuse this privilege, that individual is held liable. Castleberry v. Branscum, 721 S.W.2d 270 (1986). The court specifically lists reasons for disregarding privilege:
When the fiction is used as a means of perpetrating fraud;
Where a corporation is organized and operated as a mere tool or business conduit of another corporation;
Where the corporate fiction is resorted to as a means of evading an existing legal obligation;
Where the corporate fiction is employed to achieve or perpetuate monopoly;
Where the corporate fiction is used to circumvent a statute; and
Where the corporate fiction is relied upon as a protection of crime or to justify wrong.
2. Create the Entity with Anonymity
If people think you’re judgment proof, they’re less likely to sue you because they think that there are no assets to collect on. In other words, you’re less of a target for lawsuits.
Anonymity reduces the risk of harm or dangers to you.
Anonymity limits access and knowledge to your financial information.
3. Implement Terms in the Lease that Protect the Landlord
The Texas Realtors Residential Lease Agreement is commonly used among landlords, however it's not a catch all agreement for terms that protect the landlord. If there are specific terms, not already in the lease agreement that offer additional protection and that are permitted by the Texas Property Code, add them. While this sounds like common sense, common sense is not always common. At Texas Real Estate & Business Law Firm PLLC, we draft, review and implement terms to increase protection for landlords.
Read the entire lease agreement to make sure you understand yours and the tenant’s rights and responsibilities.
Put your expectations in the lease agreement so in the event that issues arise, those issues are addressed.
4. Purchase an Umbrella Insurance Policy
Umbrella Insurance Policies are used as additional coverage after landlord liability insurance is reached.
It’s also used for claims from a tenant, guest, or adverse possessors on vacant property injured on the property. Arguably, adverse possessors have a higher burden to prove the owner's responsibility of injury.
Unlike property-specific insurance policies, an umbrella policy can provide coverage for multiple rental properties in different cities and states. It may even cover the landlord's residence.
5. Require Tenants to Buy Renter’s Insurance
The benefits of renter’s insurance is that it covers loss of personal property due to theft and negligent destruction from tenant to landlord’s property among other things. This is especially important when tenants are judgment proof and recovery from tenants are unlikely.
This may reduce landlords from legal liabilities, help reduce insurance premiums for landlords, and help with tenant screening.
6. Understand Landlord Responsibilities & Rights and Tenants Responsibilities & Rights.
Part of protecting yourself from liabilities requires educating yourself. When leasing space to tenants, you must understand what you can and cannot do as well as what tenants can and cannot do. Landlords that do not know their responsibilities and rights are susceptible to breaking the rules. Ignorance is not a winning defense in court.
A few of landlord requirements include refunding security deposits when tenants have completed their obligations, respect Tenants’ right to use and enjoyment of the property, and follow the Federal Fair Housing Act.
7. Maintain the Property in Safe Condition.
Keep the property habitable for tenants. This means landlords should maintain their rental property in a livable condition. It’s generally in the landlord's best interest to mitigate health and safety issues.
Keep the property in a reasonably safe condition to minimize personal injuries. Landlords are not required to fix every potential hazard. If the tenant created an unsafe condition, the tenant is likely to be liable. The landlord is not liable for the tenant's injury to himself/herself. There are limits that protect the landlord from the property’s condition.
8. Follow Proper Eviction Procedure
Texas Property Code Section 24 and Texas Rules of Civil Procedure 500 lays out rules for tenants to abide by. Courts frown upon landlords that do not follow these rules. Additionally, landlords may be penalized for improper evictions.
Insurance coverages do not protect landlords from improper evictions.
Tenants may have viable claims against landlords who do not follow the proper procedure such as locking the tenant from the property, providing the wrong content or incorrect delivery of written notice to vacate.
To learn more about asset protection, contact the real estate attorneys at Texas Real Estate & Business Law Firm PLLC. (link here for calendar)
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