Synopsis: Texas is a large real estate, banking, and energy market. Leaders tout Texas as a business-friendly state and this is true. But Texas is not an investor-friendly state. Texas lacks effective judicial and enforcement procedures for banks, investors, and creditors to recover their loans and investments. Texas LLCs have become tools for money laundering.
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The Texas economy leads in real estate, banking, and energy. Texas leaders proudly proclaim Texas is open for business. The Governor and Legislature created a new Business Court and a new appeals court to adjudicate business disputes, appealing to companies seeking a lighter judicial hand from traditional corporation states such as Delaware.[1] The message is Texas is business-friendly.
This is certainly true. If you run a business or company and want a location with fewer and less enforced financial and corporate regulations and restraints, Texas is the place for you. If you are investor or lender, however, beware. Texas is a place where you will not easily get your money back if the deal goes south. Before you invest significant money in a start-up, or you loan money for a real estate, technology, or development project, you must understand you are accepting big risks you will never see your money again. Here is how to protect yourself and your client.
First: Never invest your money in a Texas LLC without personal individual guarantees by all the owners, members, and executives.
The most popular corporate structure in Texas is a limited liability company (“LLC”).[2] LLCs have advantages. In theory, an individual’s membership interest in an LLC constitutes a form of property, just like a stock or bond. The Legislature declared, “a membership interest in a limited liability company is personal property.”[3]
But in 2007 and 2023, the Legislature quietly blocked all effective means for any investor, judgment creditor, or receiver to get their money back from an individual or company holding cash or assets in an LLC by restricting recovery to one means only: a voluntary, unenforceable court charging order: “The entry of a charging order is the exclusive remedy by which a judgment creditor of a member or of any other owner of a membership interest may satisfy a judgment out of the judgment debtor’s membership interest.”[4]
A “charging order is the exclusive remedy by which a judgment creditor of a partner or any other owner of a partnership interest may satisfy a judgment out of the judgment debtor’s partnership interest.”[5]
Texas courts—not appreciating the damage to Texas investment—have applied this language literally, blocking investors, creditors, and receivers from recovering cash or real estate from individuals or companies which owe money, when the cash or property has been placed in an LLC.[6] A charging order is merely an easily evaded, voluntary instruction by a court that if the LLC ever decides to distribute money or property, which it does not have to, the LLC must send the money to the creditor or receiver. There are a thousand ways to avoid a charging order.
Second: Even if you obtain a security agreement, you are at risk if the borrower has the asset titled to an LLC. Get additional guarantees, or get a deed of trust directly with the real estate owning LLC.
You might say to yourself, “This LLC problem does not affect my investor client because we secure our loans to individuals and corporations with promissory notes and deeds of trust. In a default we will foreclose.” Yes, your client’s investment might be secure, and your client probably will be able to foreclose on the real property when there is a default. But here is your risk if the individual borrower (or a partner) defaults and you want to foreclose against his LLC interest (or his LLC partnership interest) in real property. The statutes do not say that non-judicial foreclosure is allowed against real property held by a member’s or partner’s LLC.[7]
Courts have applied the statute literally, as written, without allowing exceptions for insolvent LLCs, or LLCs which have lost their charters, or fraudulent transfers by owners who transfer real estate and cash from LLC to newly created LLC. Courts require the investor or creditor to file one suit after another to obtain a jury or court verdict that the transfer to the LLC was fraudulent, or the LLC is an alter ego of the debtor.[8] Your lender client may initiate a non-judicial foreclosure against real property owned by your debtor’s LLC and find itself blocked by an injunction asserting your client’s only remedy against the LLC is an unenforceable charging order. Get additional individual guarantees, or get a deed of trust directly with the real estate owning LLC.
Third: You, the lender or investor, must control all cash, and pay all operating costs directly. Do not hand investment money directly to the borrowing company, especially if an LLC.
When you set up the investment or loan, think through how you will recover your client’s money on default. Rather than hand the borrower or entrepreneur millions of dollars and trust him or her to invest and track the money as promised, create a company to control all disbursements. Your control company, holding the investment, will release money to the borrower a little at a time, supported by invoices, contracts, vouchers, that each disbursement is proper. If the borrow is a fraudster, you will find out soon enough and protect most of your investment.
Remember the basics. Never trust anyone. Guard against the worst. Understand that Texas is business friendly but investor unfriendly. Protect your clients.
[1] Texas Judicial Branch (https://www.txcourts.gov/businesscourt/).
[2] Tex. Bus. Orgs. Code, Ch. 101 (Limited Liability Companies).
[3] Id. at 101.106(a).
[4] Id. at § 101.112(d).
[5] Id. § 153.256(d).
[6] See, e.g., Pajooh v. Royal W. Invs. LLC, 518 S.W.3d 557 (Tex. App.—Houston [1st Dist.] 2017, no pet.)
[7] See Tex. Bus. Orgs. Code § 153.256(d) (“charging order is the exclusive remedy by which a judgment creditor of a partner or any other owner of a partnership interest may satisfy a judgment out of the judgment debtor’s partnership interest.”).
[8] See, e.g., Klinek v. LuxeYard, Inc., 672 S.W.3d 830, 839 (Tex. App.—Houston [14th Dist.] 2023, no pet.) (court acknowledged Klinek committed fraud, but found his cash and real estate holding LLC memberships interest off limits to anything but a charging order, therefore beyond victim’s reach).
