A very important and hard lesson learned

[Dan_Eisenhauer]

Recently I have run into a situation that I feel all of us can learn from. I pass it along FYI.

About 18 months ago I bought a 4plex in NE Edmonton, in my own name. (All my current holdings are held personally.) The seller took a sizable VTB.

Here is the Coles Notes version of the story.

In February one of the downstairs tenants reported a leak over the bathroom tub/shower. Investigating we found it came from the unit above. We also learned that the is SIGNIFICANT mold damage behind this one bathroom`s walls. We learned, too, that a previous repair, probably done by the Sellers, consisted of using plywood as a backer board in the shower stall above this bathroom. That plywood has now rotted, and is probably the source of the leak.

In short, the downstairs unit needs MAJOR restoration, and rebuilding. The cost is far more money that I have at hand right now, and with falling values in Edmonton, I have no way to raise it.

I believe the Sellers knew of the problem, in fact created it through their poor maintenance of the property. However, my lawyers advise that I have next to no grounds for legal recourse.

I have asked the Sellers to come to the table and help with the repair, in our mutual loong term interest. However, this couple seems not to understand doing so is a win-win situation, and that failing to do so in this case will end up being a lose-lose. Rarely have I come across anyone who is so rigid and controlling.

This property is probably going foreclosure. (Anyone want a good deal?) However, because all of my portfoilio is in my name, with fallen values recently, I am at risk of losing the entire portfolio in the domino effect.

The lesson I have learned is that all future purchases will be behind a coroprate shield. That would not prevent the loss of the first property in this case, but it would probably stave off the domino effect.

Yes, having a number of incorporations can be expensive to operate. However, we can lose our properties through no fault of our own when something in one goes south, putting everything held personally at risk. The several hundred $$ per year additional expense for a corporation pales in comparison to losing hundreds of thousands of dollars if things go wrong.

There is no longer any question in my mind about whether or not to incorporate. I hope you do not have to learn the hard way.

 

[Dan_Eisenhauer]

Am I the only one having problems editing posts? I see some typos, etc in the above post that I cannot correct.

Moderators?!?!

 

[RedlineBrett]

Not a lawyer, but you may be able to move the other properties into a corp before losing the first one. If you go into foreclosure you could be six months away from an actual judgment which would give you some time to arrange things.

Also have a look at the mortgage contract you signed. Your lawyers may be able to sheild the claim to just the property involved. If they`re in first place and the seller has a sizeable VTB they`ll likely be made whole and you`ll be fine. The seller may try and take out another property but if you have a counterlclaim that they knew about these damages beforehand they may be hesitant to take a run at you.

I know it must seem like the sky is falling but I bet if you look at it closely things aren`t as bad as you may feel they are. Just my $0.02.

 

[RedlineBrett]

Also now that I think about it as a small investor you would have to personally guarantee any loan you take (we have) so having a corp might not be all you think it is... Maybe I need to talk to my lawyer about this... hmm

 

[Smitty]

QUOTE (Dan_Eisenhauer @ Apr 8 2010, 01:12 PM) This property is probably going foreclosure. (Anyone want a good deal?) However, because all of my portfoilio is in my name, with fallen values recently, I am at risk of losing the entire portfolio in the domino effect.

The lesson I have learned is that all future purchases will be behind a coroprate shield. That would not prevent the loss of the first property in this case, but it would probably stave off the domino effect.

Yes, having a number of incorporations can be expensive to operate. However, we can lose our properties through no fault of our own when something in one goes south, putting everything held personally at risk. The several hundred $$ per year additional expense for a corporation pales in comparison to losing hundreds of thousands of dollars if things go wrong.

There is noo longer any question in my mind about whether or not to incorporate. I hope you do not have to learn the hard way.

Wow. I really feel badly for you. That just plain sucks. I was wondering though, could you sell other properties in anticipation of having to deal with the foreclosure process (if it comes to that?) Wouldn`t your entire portfolio only truly be at risk in the case of a lawsuit? I say that, because really in the end, as a matter of practicality and dollars, if the bank is repaid their mortgage, and the seller is repaid their VTB, and you had the cash form the sale of other properties to cover any shortfalls, wouldn`t that suffice? I know that the above would still be costly, but I am not sure I understand why your entire portfolio is at risk, unless the shortfall was so great on this property that selling others wouldn`t meet the financial requirements.

I`ll also echo Brett`s comments about shielding your other properties, but I have no experience in the matter.

But most of all, thank-you for sharing; your lesson, while painful, does offer a perspective probably overlooked by many of us.

Smitty
P.S. Is there anything in the VTB mortgage documents that would essentially force the seller to share the potential losses? Aren`t they also on the hook for the property`s performance?
P.P.S. As far as editing goes, the REIN forums are nearly impossible to edit or even post using the latest version of Firefox. Not sure if that`s your problem; but I`ve had better luck with IE 8 (as much as I don`t like IE).

 

[gwasser]

QUOTE (Dan_Eisenhauer @ Apr 8 2010, 01:12 PM) NB


NBRecently I have run into a situation that I feel all of us can learn from. I pass it along FYI.

About 18 months ago I bought a 4plex in NE Edmonton, in my own name. (All my current holdings are held personally.) The seller took a sizable VTB.

Here is the Coles Notes version of the story.

In February one of the downstairs tenants reported a leak over the bathroom tub/shower. Investigating we found it came from the unit above. We also learned that the is SIGNIFICANT mold damage behind this one bathroom`s walls. We learned, too, that a previous repair, probably done by the Sellers, consisted of using plywood as a backer board in the shower stall above this bathroom. That plywood has now rotted, and is probably the source of the leak.
....

There is noo longer any question in my mind about whether or not to incorporate. I hope you do not have to learn the hard way.


Is there a first mortgage in addition to the VTB?

In that case, the sellers may not be able to foreclose without the first mortgage lender. Also, your liability may still be limited because the first mortgage will have to be repaid out of foreclosure proceeds, but the VTB may not have to repaid beyond the remaining sale proceeds from the house. Something worth checking out?

 

[Thomas Beyer]

QUOTE (Dan_Eisenhauer @ Apr 8 2010, 01:12 PM) ...

The lesson I have learned is that all future purchases will be behind a corporate shield. That would not prevent the loss of the first property in this case, but it would probably stave off the domino effect....
Why is that ?

Usually you sign a personal guarantee on a mortgage that is held in a corporation unless the loan is below 60% LTV.

Thus, a mortgage default would require you to come up with $s personally, and failing to do so you would be in a similar situation.

The lesson learned is:

Cash is King - Cash-Flow is Queen ™

i.e. have enough cash to cover these routine R&M expenditures .. so if one moldy bathroom causes bankruptcy you were too levered !

 

[Dan_Eisenhauer]

Thanks for the comments everyone.

A number of situations collided at the same time to create a lack of sufficient cash to make the repairs. I feel as if I am in "The Perfect Storm". The intent of my telling this story is to make others realize that perils, sometimes beyond our controls, can affect us. I accept full responsibility for what has happened, without going into the details. However, I have learned to create as much protection for my assets as I can in the future.

Yes, corporate veils can be gone around when giving your personal guarantee. However, they add a level of protection that could prevent the house of cards coming down at the same time. Incorporation prevents Plaintiffs from getting at assets behind that veil. They can only go after what you own in your name.

There is no magic bullet that will protect us from every possible scenario. I just wanted to give my reasons why I have now changed my thinking about incorporating.

Another lesson I have learned is that I am fed up with what Tony Peters calls "tenants and toilets". It is time to chose a different strategy for me to earn my keep.

 

[OntarioInvestor]

QUOTE (RedlineBrett @ Apr 8 2010, 02:25 PM) Not a lawyer, but you may be able to move the other properties into a corp before losing the first one. If you go into foreclosure you could be six months away from an actual judgment which would give you some time to arrange things.

Also have a look at the mortgage contract you signed. Your lawyers may be able to sheild the claim to just the property involved. If they`re in first place and the seller has a sizeable VTB they`ll likely be made whole and you`ll be fine. The seller may try and take out another property but if you have a counterlclaim that they knew about these damages beforehand they may be hesitant to take a run at you.

I know it must seem like the sky is falling but I bet if you look at it closely things aren`t as bad as you may feel they are. Just my $0.02.

What you`re proposing is likely a Fraudulent Conveyance.

In Ontario.....http://www.e-laws.gov.on.ca/html/statutes/...tes_90f29_e.htm


Essentially the transaction would get reversed (put back into your name) and you`d have to pay your creditor`s legal bill on top of it.

I would imagine Alberta has similar legislation.

 

[Thomas Beyer]

QUOTE (Dan_Eisenhauer @ Apr 8 2010, 06:22 PM) ... They can only go after what you own in your name.

... Such as shares of your corporations ...

 

[Nir]

Hello Dan,

What a difficult situation! thank you for sharing. sounds like you might have a few options. I just hope one will work for you like either suing or somehow working with the seller.

This reminds everyone of the real risk in (or how risky are) RE investments. I mean, what could Dan do differently to prevent this from happening!!!???

Regards,
Neil

PS.
*Did you have a detailed home inspection done by a CAHPI member prior to purchasing?
** is a professional home inspector expected to identify such a problem beforehand?

 

[Dan_Eisenhauer]

There was an inspection carried out. That bathroom was humid, but with dry walls. The only comment made by the inspector was to advise the tenants to keep the bathroom van running after taking a shower.

The legal advice I am getting is that I have little cause for legal action.

I am trying to have a neutral third party, who knows all the options, intercede with the Sellers on my behalf. I have presented several options to them, all of which have been rejected or ignored. I am somewhat hopeful this person can make them see the best way out for all of us is to work together.

We should know by this time next week whether or not they will see it as we do. I will keep you posted.

As for incorporating... the lawyers advise doing so in order to protect your assets. The accountants say don`t do it because of the expense. I will now take the lawyers` advice. Not incorporating may cost me far more that the corporation annual fees and expenses.

That is the point of my original entry. There are pros and cons of each. Just know what they are for each, and weigh for yourself the advantages or disadvantages. Repeating myself... I am now for incorporating.

Smitty, you are right. I use Firefox as my browser. Using IE I can make those edits. Thx for letting me know of that quirk.

 

[Pheenix]

QUOTE (Dan_Eisenhauer @ Apr 9 2010, 01:27 AM) The legal advice I am getting is that I have little cause for legal action.

I am trying to have a neutral third party, who knows all the options, intercede with the Sellers on my behalf. I have presented several options to them, all of which have been rejected or ignored. I am somewhat hopeful this person can make them see the best way out for all of us is to work together.

Hi Dan
It pains me to hear stories like this.

As for my 2 cents, remember that the law can be used as a hammer. It is about whether you have sufficient cause to start, not about the possibility of winning, the case. Often the filing of an action, or formal threat of it, will bring the other party to the table, which is your real intention. Have your lawyer look for any thread, however weak.

Think about the course of negotiations during your purchase, were they hard or soft in that process, what was their style? Was it a good deal for you at the time or did you think shortly after that you could have done better (and I don`t mean buyers remorse)? Based only on that experience should you have walked away at the time, been suspicious of their manner? Very cynically, they may be perfectly happy to foreclose, take the property back at the reduced value, do some shoddy fix, re-rent and resell, while chasing you for the difference. (many people have made fortunes by selling a business, let the new owners fail and repurchasing at a discount)

As a landlord and property owner the vendor may have a lot of scars and only needs to know you are serious before taking a step forward themselves. Or, they may be truly selfish and unreasonable people who take great delight in tough, nasty negotiations and you will then have to weigh up the risk of a legal battle (and remember only lawyers win). Thinking about the first encounter will help inform this one.

Most cases of this type of dispute do not end up before a judge because the legal system is geared to `encouraging` settlement. (In fact I`m told judges often get impatient if they think it should not have reached the court room.)

If the neutral party doesn`t get them talking make sure you have a good lawyer. You might ask friends and associates who is the most difficult lawyer around, and having identified them, ask around the same circle to see who has been most successful in dealing with the difficult lawyer, in resolving not litigating - the second one is who you want. This person will probably be a very skilled negotiator.

I`m not a lawyer, but if they have the only mortgage then just stop paying and let them come after you, start playing a cat and mouse game. Force them to get legal advice and spend money - ask your lawyer how best to annoy them without going so far as to be unable to remedy and inadvertantly triggering the foreclosure and ensuing damage to you, your finances and your reputation. Again it is not about trying to `make them to pay` but to get them talking to you.

As an alternate strategy, look for a renovation partner/purchaser, who is willing to step in and pick it up, to prevent the first domino falling, if it means you don`t get pulled under by it all. Pay them to take it! - you lose but hopefully less than in the prospect you are currently facing - you`ll have to work the numbers, and consider the non-financial results.

I truly wish you good luck.

 

[Dan_Eisenhauer]

Thanks for the advice, Pheenix.

I think you nailed the Sellers perfectly. They seemed rigid from the very start. I cannot read them because they have not responded to any of the suggestions I have made that makes this a win-win. They have not communicated with me in anyway. I have no idea what motivates them. These two are the most frustrating people I have ever had to deal with in my life. Thankfully, I do not have to live like they do.

I proceeded with the purchase because I felt I could turn a long in the tooth property into something with increased value from my sweat equity. However, I bought it in October 2008, just before the market collapse. That is one of the contributing factors to the problem. I have spent close to $30K improving the property, so far.

I think I have exhausted the legal route.

I am talking with potential white knights who know the entire situation. Options are becomiing fewer and fewer. We may get out of this with our shirts on yet... although it might be a tattered T-shirt.

 

[housingrental]

Hi Dan,

I`m sorry to read your situation and hopefully this turns out well.

Would a moisture meter from the home inspector found this issue?

I`m not sure if I`m understanding your post correctly but from reading it seems like the seller had a poor quality reno job done at some point. Isn`t this is something that can happen with any property you purchase? I don`t see how the seller could be liable for this? Or why you would think its reasonable for them to be or renegotiate the terms of loan payment to them?

As Pheenix has pointed out bringing in a contractor type as partners might be a good path to look at.

Another thought I have is have you exhausted all possible private lenders?

Or looked to contracting companies that will do the work and provide financing for this? Ie you might only need to come up with very little $$ immediately to take care of problem and have a few years to pay it off and find funds elsewhere.

 

[Nir]

Dan, pls keep updating on this. you got some great advice from Brad and others.Everyone, so what should be the conclusion re incorporating:

1. Putting the property under a corporation does reduce personal risk significantly as Dan mentioned:
"Yes, corporate veils can be gone around when giving your personal guarantee. However, they add a level of protection that could prevent the house of cards coming down at the same time. Incorporation prevents Plaintiffs from getting at assets behind that veil. They can only go after what you own in your name."

OR

2. It doesn`t as Thomas explained that they can go after what you own in your name "Such as shares of your corporations"?



Any input from someone with either legal or personal experience who either benefited from incorporating or not, would be interesting.

An important and interesting discussion for any RE investor.

Regards,
Neil

 

[JanBowler]

This is a sad situation for sure, Dan. One that could happen to anyone from the sounds of it. But what you are saying about incorporation isn`t what we`ve heard. Ron Le Grand teaches it along with asset protection, but I don`t think it is the case here - we understood that if you own something in your personal name instead of a corporation, then you only lose that one property if there is foreclosure on it, not the rest of your portfolio. It is supposed to be a benefit of owning in your own name. If you have learned more since your last post on this topic, won`t you please share so we can benefit from your journey.

 

[Esaum]

QUOTE (investmart @ Apr 10 2010, 07:21 PM) 2. It doesn`t as Thomas explained that they can go after what you own in your name "Such as shares of your corporations"?


I know several people who don`t actually own their corporation shares in their name (Wife`s name). Therefore there is no recourse to come after the corporation`s shares. You can have a controlling interest without having a ownership interest...

 

[DaveRhydderch]

Brutual story, but thanks for sharing.

The one thing I`ve learned from looking at a lot of properties (and not saying this would have help necessarily) is to really look at the condition of the home. If you see quick fixes or small things that are wrong, it can tell you a lot more about the home.

This is a tough situation. Good luck.

 

[gwasser]

QUOTE (Esaum @ Apr 15 2010, 07:26 AM) I know several people who don`t actually own their corporation shares in their name (Wife`s name). Therefore there is no recourse to come after the corporation`s shares. You can have a controlling interest without having a ownership interest...

The liability aspects of incorporation are much more complex than many assume. For example, professional corporations may keep the professional liability with the owner rather than with the corporation. Going back to realty though, when incorporated you are shielded from all liabilities except where you assume it through personal guarantees. Also there is the requirement for the officer(s) in charge to act in the best interest of the corporation which is a legal person.

For a company holding primarily real estate this probably means that you are shielded against building accidents and liabilities stemming from its management other than the assets of the corporation itself. However, if you take out mortgages it is common practice to personally guarantee the mortgage and if this goes sour you are personally on the hook. Most banks and other commercial lenders require such a personal guarantee. I don`t know about VTB`s maybe there you may get away without giving a personal guarantee.

Having a corporation requires you to do proper book keeping, having an accountant doing your taxes is good business practice because of the interaction between you and your corporation. So count on $2000 per year plus another $1000 for having the accountant doing your personal taxes. For me that is worth the money. The initial costs to incorporate using a lawyer, highly advisable, is around $600 plus an annual bill if $250 for the annual return. In fact that last you can easily do yourself and thus that saves some bucks.

The real pain is the GST. If possible do it on an annual basis together with your corporate taxes. I used to do my normal accounting including GST on Quickbooks. These days I use a simple Excel spreadsheet.

My real estate is held privately but I do not play the high leverage game. But now with a JV in the making, I am considering seriously to set up company number 3 or is it 4? My wife has her own professional corporation and I use one as well, although it also holds stock market holdings. Then we had this company that marketed various consulting services overseas. It was never very succesful and we folded it.

Do I like corporations? No they are a pain. We seem to be doing taxes all year long. The current tax advantages are limited and once they build up some equity corporations become wealth traps. But when taxes are on the rise again and to create clean partnerships I thing they are the way to go.

Dan, I hope you find a way out of your current mess. Rather than worrying about incorporation and legal action, I suggest you focus on cleaning up. The first step in clearing up a mess is taking careful inventory.
I would suggest to have your lawyer review the VTB agreement to see what practical options you have in that area.I would simultaneously try to really review thoroughly what assets and debts you have; what you can convert quickly and painlessly into cash and sell the property that is causing you so much grieve, even if it is at a loss. Creating a clean well organized business even with a temporary set back will help you recover at maximum speed. Hope this helps.