U.S. Department of Housing and Urban Development H O U S I N G Special Attention of: Notice H 95-66 (HUD) Secretary s Representatives; State Coordinators; Directors Issued: 7/25/95 of Housing; Directors of Multi- Expires: 7/31/96 family Housing; and Chief Counsels Cross References: HB 4430.01 REV-1 HB 4425.1 HB 4350.01 REV-1 Form HUD-92466 Subject: Requirements for Accepting Limited Liability Companies and Partnerships as Mortgagor Entities for Insured Multifamily Housing Projects A. PURPOSE: This Notice provides: 1. Implementing Instructions concerning the acceptance of limited liability companies (LLCS) as mortgagor entities, and as general partners or partners of mortgagor entities, for: a. New applications for mortgage insurance, and b. The transfer of physical assets (TPA) to a LLC, the conversion from a partnership mortgagor entity to a LLC, the conversion of the general partner of a limited partnership (LP) mortgagor or partner of a general partnership (GP) mortgagor to a LLC, and the transfer of interests to new members in a LLC mortgagor. 2. Requirements for The Organizational Documents of LPS and GPs for new applications for mortgage insurance and TPAs to: a. Help protect HUD's interests in the mortgage and to preclude modification of the partnership agreements in a manner that would violate HUD's requirements, and b. Maintain consistent HUD requirements in certain areas of concern in which mortgagor entities function essentially the same. B. BACKGROUND -- LLCs AS MORTGAGORS: 1. Industry and Staff Inquiries indicate an increasing interest in LLCs as mortgagors and general partners. 2. Current Statutory and Regulatory Provisions do not preclude acceptance of LLCs as mortgagors for the mortgage insurance programs, subject to certain provisions. See Sections 207(b)(2), 213(a)(3), 220(d)(2), 221(d)(3), 221(d)(4), 231(c)(4), 232(d)(1) and 234(d) of the National Housing Act and 24 CFR Sections 207.17(a), 220.505(a), 221.510(a)(2),(c),(d)(2), and (e), 231.1, 231.2(f), 232.20(a) and 234.501 which incorporates 207.17(a). 3. LLC Legislation has not originated from a uniform act as did LP legislation, therefore, variations between state provisions affecting LLCs are more extensive than for LPS, and greater attention to organizational documents is required by the mortgagors' and HUD's attorneys. C. BACKGROUND -- PARTNERSHIP ORGANIZATIONAL DOCUMENTS: There have been limited instructions and a lack of uniform guidance regarding provisions in the organizational documents for GP and LP mortgagor entities concerning the modification of those documents in a manner that would affect HUD's interests. (See, e.g., Instructions to Closing Attorney at p.1 of Form HUD-92466.) This Notice gives additional guidance in this area. D. COMMITMENT REQUIREMENTS FOR LLCS, GPs AND LP s AS MORTGAGORS: 1. New Commitment: When an application is made for a LLC, GP or LP mortgagor, include as special conditions of the Firm Commitment compliance with: (1) the "HUD Requirements for LLC, GP and LP Mortgagors" in paragraph F below, and (2) the requirement for "Specimen Provisions for Organizational Documents" set forth in paragraph G below. 2. Existing Commitment: When the sponsor wishes to change to a LLC, GP or LP mortgagor after HUD has issued a Firm Commitment that does not call for compliance with paragraphs F and G, the existing Firm Commitment may be amended by mutual agreement between HUD, the mortgagee and the sponsor to add as special conditions the mortgagor's compliance with paragraphs F and G below. a. Recite in a letter accompanying the amended Firm Commitment that the new special conditions are in consideration of HUD's agreeing to accept a change in mortgagor. b. The mortgagor and mortgagee shall evidence their consent to the amendment by returning the HUD letter bearing their signed statement of acceptance or by separate letter on the mortgagee's letterhead. E. UNACCEPTABLE CONDITIONS INCLUDE: 1. A LLC, GP, or LP Mortgagor that does not meet the requirements of paragraphs F and G below. 2. The Following Occur Without Prior Written HUD Approval: a. Conversion of: (1) A GP or LP mortgagor to a LLC mortgagor, (2) The partner of a GP mortgagor to a LLC, (3) The general partner of a LP mortgagor to a LLC, or b. Substitution or addition of a new LLC member. NOTE: Such unauthorized actions are subject to HUD's enforcement actions, regardless of potentially conflicting state laws. 3. Mortgagor Proposals Conflict With HUD Requirements: a. It is expected that HUD generally will rely upon a LLC's compliance with paragraphs F and G below, including the opinions of mortgagor's counsel. b. The Director of Housing, however, may reject a LLC as a mortgagor or general partner of a LP or GP mortgagor if HUD's Local Counsel advises that state law or provisions of a LLC's Articles of Organization, Operating Agreement or other controlling documents, however designated, conflict with HUD's requirements. NOTE: Greater reliance upon a single comprehensive national instruction may be possible upon gaining greater experience in state variations and court interpretations for such mortgagor entities. F. HUD REQUIREMENTS FOR LLC, GP and LP MORTGAGORS: The type of mortgagor subject to each requirement is identified within brackets []. Note that mortgagors still are subject to other requirements contained in outstanding regulations and guidelines. 1. All LLC members must execute a rider to the HUD note, mortgage and Regulatory Agreement, in accordance with paragraph H. of this Notice, that makes them individually liable to HUD as guarantors: [LLC] a. For funds or property of the Project coming into their hands, which by the provisions of the Regulatory Agreement, they are not entitled to retain; b. For their own acts and deeds, or acts and deeds of others which they have authorized, in violation of the provisions of the Regulatory Agreement; and c. For their acts which violate statutes governing the conduct of owners of multifamily projects with FHA-insured mortgages. NOTE: The guaranty of each member in his or her individual capacity is required because some members might assert that the state law under which their LLC is organized does not permit a member of a LLC to undertake liability as a member of the LLC. 2. In addition to paragraph 1. above, any member-manager, member with governance interests equalling or exceeding 10 percent, or member with financial interests equalling or exceeding 25 percent, shall be liable on a joint and several basis, in the amount of any loss, damage or cost (including but not limited to attorneys' fees) resulting from fraud or intentional misrepresentation by the mortgagor, the mortgagor's agents or employees or a member of the mortgagor in connection with obtaining the loan evidenced by the note, or in complying with any of the mortgagor's obligations under the loan documents. [LLC] 3. Any member of a LLC mortgagor and LLC general partner or partner must be a natural person. [LLC] 4. The entity must be formed, or qualified as a foreign entity, under the laws of the state in which the insured property or proposed insured property is located, i.e., the property jurisdiction. [LLC/GP/LP] 5. The articles of organization must be executed in accordance with state law. [LLC] 6. The LLC must be governed by an operating agreement that is executed by all members. [LLC] 7. The partnership agreement must be executed in accordance with state law and executed by all general partners, and where applicable, all limited partners. (GP/LP) 8. Any specified duration of the mortgagor entity in its organizational documents must not be less than the term of the HUD-insured or coinsured mortgage, including the construction period when insured advances are a consideration. [LLC/GP/LP] 9. The entity must be a single-asset entity as described in paragraph 6(f) of the Regulatory Agreement, Form HUD-92466. [LLC/GP/LP] 10. The entity must have authority to legally purchase or hold in its own name a mortgageable interest in real property in the property jurisdiction. [LLC/GP/LP] 11. The organizational documents may not contain any provision that is inconsistent with the obligations to be undertaken by the mortgagor under the note; mortgage, deed of trust or security deed; security agreement; and regulatory agreement. [LLC/GP/LP] 12. The operating agreements for LLCs and partnership agreements for GPs and LPS must include provisions stating that: a. If any of the provisions of the organizational documents conflict with the terms of the note; mortgage, deed of trust or security deed; security agreement or HUD Regulatory Agreement ("Regulatory Agreement"), the provisions of the note, mortgage, deed of trust, security deed, security agreement or Regulatory Agreement will control. [LLC/GP/LP] b. No provision required by HUD to be inserted into the organizational documents may be amended without prior HUD approval, so long as HUD is the insurer or holder of the note. [LLC/GP/LP] c. Any party acquiring any of the following positions anew must meet the applicable requirements for HUD previous participation clearance: [LLC/GP/LP] (1) Manager of the mortgagor entity whether or not a mortgagor member, (2) General partner, (3) LLC member with 10 percent or greater governance interest, and (4) Limited partner or LLC member with 25 percent or greater financial interest. d. So long as the Secretary of HUD or the Secretary's successors or assigns is the insurer or holder of the note on the project, without the prior written approval of the Secretary: (1) The mortgagor entity may not be voluntarily dissolved or changed to another type of entity [LLC/GP/LP], (2) The partner of a GP mortgagor or general partner of a LP mortgagor may not be voluntarily changed to a LLC [GP/LP], and (3) A member may neither be added nor substituted. [LLC] 13. The mortgagor entity shall: [LLC/GP/LP] a. Designate an official representative[s] for all matters concerning the project which require HUD consent or approval, and the signature of this person [these persons] shall bind the mortgagor in all such matters, b. Identify where a partner-manager[s] or member-manager[s] is vested with management authority in any project matters other than noted in paragraph a. above, and identify such management authority and manager[s], and c. The mortgagor may from time to time appoint a new representative to perform such functions, but within 3 business days of doing so, shall provide HUD with written notification of the name, address, and telephone number of its new representative[s]. 14. Where appropriate because of state law, include provisions for the following concerns in the Articles of Organization in addition to or in lieu of their inclusion in the Operating Agreement, as may be provided by paragraph G of this Notice: [LLC] a. Duration of the LLC, b. The right to continue the LLC after dissociation of member, and c. Vesting of management authority in a member-manager for all matters concerning the project which require HUD consent or approval. 15. If the mortgagor is a LLC, in addition to the other legal opinions to be provided within the comprehensive opinion of mortgagor's counsel required by HUD Handbook 4430.1 REV-1, "Initial Closing for Project Mortgages": [LLC] a. Mortgagor's attorney must opine to the authority of the LLC's members, under applicable state laws and the LLC's organizational documents, to execute and perform under the terms of the Regulatory Agreement and the LLC Rider to the Note, Mortgage and Regulatory Agreement; b. If the property jurisdiction is not the state of formation for the LLC, mortgagor's attorney must opine that the LLC is qualified to hold title to real property and transact business in the property jurisdiction; c. Local Office Counsel may, in their discretion, require additional legal opinions or legal analysis regarding the LLC from mortgagor's or mortgagee's counsel as appropriate in light of state law. NOTE: The current "Guide for Opinion of Mortgagor's Counsel" should be adapted to include any legal opinions of mortgagor's counsel required or permitted by this paragraph. G. SPECIMEN PROVISIONS FOR ORGANIZATIONAL DOCUMENTS: The operating agreement for each LLC mortgagor, and the partnership agreement for each GP and LP mortgagor (whether organized as the initial mortgagor for an insured mortgage or in relation to a TPA or conversion) must include provisions substantially as provided below. Mortgagor's attorney must make appropriate modifications to the specimen provisions to reflect applicable terminology for the specific type of mortgagor entity, and pertinent state provisions, and to conform the document with HUD's requirements. As examples: Make the following substitutions for general partnerships and limited partnerships: "General Partnership" or "Limited Partnership" for "Company," "Partnership Agreement" for "Operating Agreement," and "Partner" for "Member." "HUD REQUIREMENTS. 1. So long as the Secretary of The Department of Housing and Urban Development ("Secretary") or the Secretary's successors or assigns is the insurer or holder of the note secured by the [insert mortgage, deed of trust or security deed] on [insert project's name and FHA project number] in [insert the city or county and state] (the "Project"), no amendment to the Articles of Organization or the Company's Operating Agreement dated [insert date] (the "Operating Agreement") that results in any of the following will have any force or effect without the prior written consent of the Secretary: a. Any amendment that modifies the term of the Company; b. Any amendment that activates the requirement that a HUD previous participation certification be obtained from any additional member; c. Any amendment that in any way affects the note, [insert mortgage, deed of trust or security deed], or security agreement on the Project or the Regulatory Agreement between HUD and the Company (the "Regulatory Agreement"); d. Any amendment that would authorize any member other than the Manager or preapproved Successor Manager to bind the Company for all matters concerning the project which require HUD's consent or approval; e. A change in the Manager or preapproved Successor Manager of the Company; or f. Any change in a guarantor of any obligation to the Secretary. 2. The Company is authorized to execute a note, [insert mortgage, deed of trust, or security deed] and security agreement in order to secure a loan to be insured by the Secretary and to execute the Regulatory Agreement and other documents required by the Secretary in connection with the HUD-insured loan. 3. Any incoming member must as a condition of receiving an interest in the Company agree to be bound by the note, [insert mortgage, deed of trust, or security deed], security agreement, the Regulatory Agreement and any other documents required in connection with the HUD-insured loan to the same extent and on the same terms as the other members. 4. Notwithstanding any other provisions of the Operating Agreement or the Articles of Organization, upon any dissolution, no title or right to possession and control of the Project, and no right to collect the rents from the Project, shall pass to any person who is not bound by the Regulatory Agreement in a manner satisfactory to the Secretary. 5. Notwithstanding any other provisions of this Operating Agreement or the Articles of Organization, in the event that any provision of this Operating Agreement or the Articles of Organization conflicts with the Regulatory Agreement, the provision of the Regulatory Agreement shall control. 6. So long as the Secretary or the Secretary's successors or assigns is the insurer or holder of the note on the Project, the Company may not voluntarily be dissolved without the prior written approval of the Secretary. 7. The members, and any assignee of a member, agree to be liable in their individual capacities to HUD with respect to the following matters: a. For funds or property of the Project coming into their hands, which by the provisions of the Regulatory Agreement, they are not entitled to retain; and b. For their own acts and deeds, or acts and deeds of others which they have authorized, in violation of the provisions of the Regulatory Agreement." H. SPECIMEN LLC RIDER TO THE REGULATORY AGREEMENT: Before HUD insures a loan to a LLC, approves a TPA to a LLC, approves the conversion of the mortgagor from a partnership to a LLC, or approves the conversion of the general partner of a limited partnership mortgagor or partner of a general partnership mortgagor to a LLC, the LLC shall sign a standard-form Regulatory Agreement and a rider substantially as provided below, and amended where appropriate to comply with applicable state law. The closing attorney is to ensure that the Regulatory Agreement itself specifically refers to and incorporates the rider and that all members of the LLC sign the Regulatory Agreement and the rider. LLC RIDER TO NOTE, MORTGAGE, AND REGULATORY AGREEMENT In further consideration of the endorsement for insurance by the Secretary of Housing and Urban Development ("HUD") of the note between ___________________ ("the Owner") and ___________________, dated _______________ __, 199_, or in consideration of the consent of the Secretary to 1) the transfer of the mortgaged property, 2) the sale and conveyance of the mortgaged property by the Secretary, 3) the conversion of the mortgagor from a partnership to a limited liability company, or 4) the conversion of the general partner of a limited partnership mortgagor or partner of a general partnership mortgagor to a limited liability company, and in order to comply with the requirements of the National Housing Act, as amended and the regulations adopted by the Secretary pursuant thereto, the Owners agree as described below for themselves, their successors, heirs and assigns, in connection with the mortgaged property and the project operated thereon and so long as the contract of mortgage insurance continues in effect and during such further period of time as the Secretary shall be the owner, holder, or reinsurer of the mortgage, or during any time the Secretary is obligated to insure a mortgage on the mortgaged property. The signatories to this document undertake the following obligations in their individual capacities as guarantors and as members of the Owner, and the consideration described above runs to the signatories in both capacities. The following provisions are added to and made a part of the project Mortgage Note, Mortgage, and Regulatory Agreement, all dated ___________ __, 199_. 1. If any provision of the Owner's Articles of Organization, Operating Agreement, other organizational documents, or any later amendment to those documents, conflicts with the terms of the project loan documents (e.g., the note, mortgage, deed of trust, security agreement, security deed and/or this Regulatory Agreement), the provisions of the project loan documents will control. 2. Notwithstanding any provision of state law to the contrary, any signatory to this rider receiving funds of the project other than by distribution of surplus cash as authorized in paragraph ___, above, shall immediately deposit such funds in the project bank account and failing to do so in violation of this Agreement shall hold such funds in trust. Notwithstanding any provision of state law to the contrary, any signatory to this rider receiving property of the project in violation of this agreement shall immediately deliver such property to the project and failing to do so shall hold such property in trust. 3. Notwithstanding any provision of state law to the contrary, all signatories to this rider are liable for: a. Funds or property of the project coming into their hands which, by the provisions hereof, they are not entitled to retain; and b. Their own acts and deeds or acts and deeds of others which they have authorized in violation of the provisions hereof; 4. Notwithstanding any provision of state law to the contrary, any member- manager, member with governance interests equalling or exceeding 10 percent, or member with financial interests equalling or exceeding 25 percent, who, on the date of the Regulatory Agreement to which this Rider is attached, include the following: ___________________, shall be liable on a joint and several basis, in the amount of any loss, damage or cost (including but not limited to attorneys' fees) resulting from fraud or intentional misrepresentation by the mortgagor, the mortgagor's agents or employees, or a member of mortgagor in connection with obtaining the loan evidenced by the note, or in complying with any of the mortgagor's obligations under the loan documents. 5. All signatories to this rider will be considered agents of the Owner for the purpose of establishing liability under the double damages provision at 12 U.S.C. 1715z-4a and the equity skimming penalty under 12 U.S.C. 1715z- 19, unless HUD agrees in writing to the contrary. 6. Each signatory to this rider will be individually liable for payment of the entire amount of any civil money penalty imposed on the mortgagor pursuant to Section 537 of the National Housing Act, 12 U.S.C. 1735f-15. 7. The owner has designated __________________ as its official representative for all matters concerning the project which require HUD consent or approval. The signature of this person will bind the Owner in all such matters. The Owner may from time to time appoint a new representative to perform this function, but within 3 business days of doing so, will provide HUD with written notification of the name, address, and telephone number of its new representative. When a member other than the member identified above has full or partial authority for management of the project, the owner will promptly provide HUD with the name of that member and the nature of that member's management authority." 8. Notwithstanding any provision of state law to the contrary, no signatory to this rider shall have any right of subrogation or indemnification against the Owner or the property of the project by reason of any payment made or liability incurred pursuant to this rider or any statute to which this rider refers. I. LLC MORTGAGOR REVIEWS: 1. Mortgage Credit Examiner must review credit reports and the financial statements for the managing member(s) and each member with a 10 percent or greater ownership interest, except that financial statements are not required where the LLC is fully capitalized. 2. Conduct Previous Participation Clearance Reviews for all members with management authority, all members owning at least a 10 percent interest in the LLC, and if applicable, all officers and non-member managers. 3. Local Office Counsel must review the opinion of mortgagor's attorney to ensure that the proposed LLC is legally able to meet HUD requirements. J. GP AND LP MORTGAGOR REVIEWS: Continue all reviews as provided in outstanding instructions, and review for compliance with paragraphs F and G above. K. TPAs AND OTHER TRANSFERS INVOLVING LLC MORTGAGORS: 1. Every New Member of a LLC, regardless of the percentage or type of participation, or means of acquisition, must sign the Regulatory Agreement and Rider in accordance with paragraph H above. 2. All TPAs must comply with the requirements of paragraphs F and G of this Notice, and be reviewed in accordance with Handbook 4350.1, Chapter 13 and its Appendices A and B, as modified herein. a. Full Project Compliance must be evidenced for paragraphs b, c and d below by a HUD site inspection and/or mortgagor's certification as the Directors of Housing may determine at their discretion. b. Appendix A Review and Fee of Fifty Cents per thousand dollars of the face amount of the original mortgage is required for a: (1) Transfer of title: (a) From the mortgagor-seller to the buyer, including conveyance by an installment sales contract, land contract or wrap-around mortgage, or (b) Resulting from a mortgagor entity conversion to a LLC, where applicable state laws entail a transfer of title from the existing entity to the LLC, and (2) Transfer of any interest in a LLC which causes a dissolution of the LLC under applicable state law. c. Appendix B Review and Fee of Fifty Cents per thousand dollars of the face amount of the original mortgage is required: (1) Where more than 50 percent of the governance interests are transferred or reallocated by a single action, or any series of actions, (2) Where there is a change of control resulting from a mortgagor conversion to a LLC that does not involve a transfer of title, or the conversion of a LP or GP mortgagor's general partner to a LLC, (3) Where there is a substitution or addition of a member-manager that has not undergone reviews for previous participation clearance, or credit and financial statements for the subject mortgage within six months, and (4) For all transactions, not otherwise identified in this paragraph K that result in a change of control of the company. d. Appendix B Review and Local Office Determined Fee: (1) Applicable conditions: (a) A single transfer of between 10 percent and 50 percent governance interest, or (b) A single transfer of between 25 and 50 percent of financial interests. (2) A fee shall be charged for site inspection, document review and related tasks, as determined appropriate by the Director of Housing in consultation with Local Office Counsel: (a) After discussion with mortgagor regarding the nature and complexity of the transaction, and (b) Not to exceed 50 cents per thousand dollars of the face amount of the original mortgage. e. No TPA Review or Fee, but signed Regulatory Agreement and Rider to note, mortgage and Regulatory Agreement required for each member where there is: (1) A single transfer of less than 10 percent governance interest, or (2) A single transfer of less than 25 percent of financial interests only. L. CONVERSIONS TO LLC MORTGAGORS require prior HUD written consent to the conversion, whether or not the applicable state laws treat the new LLC as the same entity from which it was converted. A failure to obtain HUD's written consent shall be treated as an unauthorized transfer and be subject to enforcement measures. HUD's consent to the proposed conversion shall be conditioned as follows: 1. Title Transfer Involved as a result of applicable state laws. Comply with paragraph K.2.b. of this Notice. 2. Management Control Changed due to any change in the management authority or governance interests arising from the conversion, but there is no transfer of title, comply with paragraph K.2.c. of this Notice. If both a change in management control and title transfer are involved, comply with paragraph K.2.b. 3. Title Transfer/Control Change Not Involved, i.e., there is a statutory conversion of a GP or LP mortgagor in which all existing partners remain as members of the LLC without change in ownership interests or management authority, under state laws the LLC is "for all purposes the same entity that existed before the conversion," and all property of the converted partnership is either vested in the LLC without further act or deed, or remains with the converted entity. The following apply: a. Mortgagor must comply with the requirements of paragraphs F and G of this Notice, b. HUD must receive a proposed title binder or letter from the company issuing the original mortgagee's title policy that shows that after the conversion: (1) The mortgage will remain a first lien on the property, and (2) The mortgagee and HUD will still be protected by a mortgagee's title policy, c. Full project compliance must be evidenced by a HUD site inspection and/or mortgagor's certification at the discretion of the Director of Housing, d. Mortgagor's attorney must opine: (1) That the LLC complies with paragraph F.4 of this Notice, (2) In accordance with paragraphs F.15.a and b of this Notice, and (3) That the conversion will not alter any outstanding obligation of the mortgagor or its partners under the mortgage documents, and e. Payment of a conversion fee determined in accordance with paragraph K.2.d.(2) above. M. LLC GENERAL PARTNERS OF LP OR GP MORTGAGORS: 1. Any LLC That is or Will be a General Partner or Partner of a proposed or existing mortgagor must comply with the requirements and instructions in this Notice for LLCs as mortgagors, e.g.: a. Any LLC general partner of a LP or GP mortgagor must comply with paragraphs F and G of this Notice, and b. All members of the LLC must sign the Regulatory Agreement and a LLC rider to the note, mortgage, and Regulatory Agreement. 2. Conversion to a LLC of the general partner of an existing LP mortgagor or partner of an existing GP mortgagor also requires: a. Prior HUD written consent to the conversion whether or not the state law treats the new LLC as the same entity from which it was converted, b. Full project compliance, which may be evidenced at the Director of Housing's discretion by a HUD site inspection and/or mortgagor's certification, and c. Payment of a conversion fee determined in accordance with paragraph K.2.d.(2) above. N. APPLICABILITY: The provisions of this Notice are effective immediately. Questions regarding this Notice should be addressed as follows: 1. Development Issues:. Office of Insured Multifamily Housing Development, Policies and Procedures Division at (202) 708-1113. 2. Management Issues: Office of Multifamily Housing Management, Operations Division at (202) 708-0547. 3. Legal Issues: Office of Insured Housing, Assistant General Counsel, Multifamily Mortgage Division, at (202) 708-4090. ____________________________________ Nicolas P. Retsinas Assistant Secretary for Housing- Federal Housing Commissioner