The Use of Land Trusts and Delaware Business Trusts in Real Estate Transactions

and Delaware Business Trusts in Real Estate Transactions

By: John C. Murray, ©2011

Land Trusts: Definition and Uses

Common law trusts have been used for centuries to preserve and protect title to and minimize taxes on property. Florida (west’s fla. stat. ann. § 689.071); Hawaii (haw r.s. ch. 558); Illinois (see statutory references below); Indiana (ind. code §§ 13-11-1-115.5 and 30-4-2-13); North Dakota (n.d. cent. code 59-03-02); and Virginia (va. code. § 55-17-1) have statutes that permit forms of land trusts, while states such as California and Kansas have permitted the creation of land trusts through court decisions. The majority of states do not recognize, or permit the use of, land trusts. Land trusts are unique because the duties and powers of the trustee are limited, but they are still considered to be trusts and generally are governed by the principles that are applicable to all other trusts.

Black’s law dictionary 1516 (7th ed. 1999) defines “land trust” as follows:

A land-ownership arrangement by which a trustee holds both legal and equitable title to land while the beneficiary retains the power to direct the trustee, manage the property, and draw income from the trust—also termed Illinois land trust; naked land trust. (Emphasis in text.)

See also 90 c.j.s., Trusts, § 245 (2006), which describes a land trust as follows:

In “land trusts,” both the legal and equitable title to the res is vested in the trustee, not the beneficiary. The beneficial interest consists of the beneficiaries’ rights and privileges and is not characterized as a real estate interest, but as a personal property interest. However, it has also been said that a land trust is a legal fiction in which the trustee acts only in a representative capacity, and that true ownership of land subject to a land trust remains with the beneficiary, although legal and equitable title to land lies with the trustee. Thus, it has been said that the title of trustee of a land trust has little significance, outside of relationships based on legal title. The trustee has no duties or powers other than to execute deeds and mortgages or otherwise to deal with the property as directed by the holder of the power of direction, and the power of direction, which is a property interest separable from the beneficial interest, provides the possessor with the ability to direct the trustee in the manner in which he or she is to deal with the property.

Illinois Land Trusts

An Illinois land trust, which is a unique legal entity, is a creature of common law (going back to railroad acquisitions of property in the 1850s) with an overlay of statutory approval and constraints. An Illinois statute, 765 ILCS 415/2(a), provides the following definition of “land trust”:

“Land trust” means any express agreement or arrangement whereof a use, confidence, or trust is declared of any land, or of any charge upon land, for the use or benefit of any beneficiary, under which the title to real property, both legal and equitable, is held by a trustee, subject only to the execution of the trust, which may be enforced by the beneficiaries who have the exclusive right to manage and control the real estate, to have possession thereof, to receive the net proceeds from the rental, sale, hypothecation, or other disposition thereof, and under which the interest of the beneficiary is personal property only.

765 ILCS 415/2(b) defines “beneficial interest” as follows:

“Beneficial interest” means any interest, regardless of how small or minimal such interest may be, in a land trust, held by a trustee for the benefit of beneficiaries of such land trust.

Furthermore, “Holders of the power of direction,” under 765 ILCS 415/2(b) means:

[T]he persons or entities having the authority to direct the trustee to convey, execute a mortgage, distribute proceeds of sale or financing, and execute documents incidental to the execution of a land trust.

In addition, the Illinois Mortgage Foreclosure Law, 735 ILCS 5/15- 1101 et seq. (“IMFL”), provides the following definition of “land trust” at 735 ILCS 5/15-1205:

“Land trust” means any trust arrangement under which the legal and equitable title to real estate is held by a trustee, the interest of the beneficiary of the trust is personal property and the beneficiary or any person designated in writing by the beneficiary has (i) the exclusive power to direct or control the trustee in dealing with the title to the trust property, (ii) the exclusive control of the management, operation, renting, and selling of the trust property, and (iii) the exclusive right to the earnings, avails, and proceeds of the trust property.

735 ILCS 5/15-l106(a)(3) provides that any collateral assignment of the beneficial interest in a land trust may be foreclosed under the provisions of the IMFL; and 735 ILCS 5/15-1106(b) provides that a secured party, as defined in Article 9 of the UCC, may elect to enforce its security interest in a foreclosure under the IMFL if the interest was created by a collateral assignment of a beneficial interest in a land trust.

In Illinois, a land trust is a legal arrangement in which the trustee holds legal and equitable title to real property, thus making transfer of title to the property much easier. But all managerial, decisional, and operational powers over the trust assets remain under the control of the trust beneficiaries, pursuant to the land trust agreement. Unlike other trusts, the land trustee’s sole purpose is to take and hold title to the real property, i.e., the trustee is merely a nominee to hold title. The trustee takes action only when directed to do so by the beneficiaries. See generally kenoe on land trusts (1981 ed., 1985 Supp.), published by the Illinois Institute for Continuing Legal Education (considered at the time the “definitive treatise” on Illinois land trusts); 90 c.j.s., Trusts, § 254 (2006), stating that:

In a land trust, the beneficiary retains no interest, legal or equitable, in property itself, but instead holds only a personal property interest in the rents, proceeds, and profits from the property. However, it has also been said that true ownership of land subject to a land trust remains with the beneficiary, although legal and equitable title to land lies with the trustee.

Numerous Illinois court decisions have validated and construed the land trust. See, eg, Conley v. Petersen, 25 Ill. 2d 271, 273 (1962) (“The validity of such a land trust as is involved here is clearly settled in Illinois”).

A nonstandard provision of Article 9 (enacted into law in Illinois in 2001) of the Illinois Uniform Commercial Code (“UCC”), 810 ILCS 5/9-314, provides that a security interest in the beneficial interests in an Illinois land trust may be perfected by control of the collateral pursuant to 810 ILCS 5/9-107.1 (which control is accomplished by serving a Notice of Collateral Assignment on the land trustee and obtaining a written receipt from the land trustee). Section 810 ILCS 5/9-312 provides that perfection of a security interest in the beneficial interest in a land trust may be perfected by filing, but this is no longer necessary to perfect a security interest in a collateral assignment of a beneficial interest in a land trust. Although under 810 ILCS 5/9-312 the filing of a UCC-l financing statement is not required to perfect the lender’s security interest it still may be a good idea, as a precautionary matter, to file a UCC-l financing statement as well as obtain perfection by control as described above. Pursuant to 810 ILCS 5/9-306.1, the local law of the State of Illinois governs perfection, the effect of perfection or nonperfection, and the priority of a collateral assignment of, or other security interest in, a beneficial interest in an Illinois land trust. This section implements the important interest of this state in matters associated with the administration of Illinois land trusts created for the principal purpose of owning an interest in Illinois land and the regulation of restrictions on the transfer of beneficial interests in, and of the power of appointments under, such trusts.

Since a beneficial interest in an Illinois land trust is personal property, the conveyance (or transfer) of it for security purposes is usually effected by means of an assignment of beneficial interest (“ABI”). Under the original version of Article 9 in Illinois, a secured party was “automatically” perfected when it was granted a security interest in the beneficial interest in a land trust. As a result, a UCC-l financing statement usually was not filed by the secured party. As noted above, 810 ILCS 5/9-314 now specifically allows perfection by control.

Large banks in Illinois historically acted as trustees under Illinois land trusts, but very few do so currently. (A title company in Illinois has set up a land-trust company to perform this specific function as successor trustee to many banks that formerly acted as land trustees.) The trustee will not hold title to an Illinois land trust for property that is out-of-state. Title companies have no problem insuring title to property held in a land trust in those states where that form of ownership is permitted. A limited liability company (“LLC”), or any other form of business entity, may be the beneficiary of a land trust.

Title Insurance Considerations

Assuming a title insurer is willing to consider insuring a transaction where title is purportedly vested in a land trust, the following are typical requirements and issues that the title insurer considers in its underwriting analysis:

  1. Compliance with state statutes, including requiring notice to beneficiaries of transfer of the trust assets.
  2. Written evidence of the identities of all parties holding any beneficial or other interest in the trust, including spouses.
  3. Copies of any assignment of any interest, including the beneficial interests, under the trust.
  4. Written consent to the proposed transaction by all parties holding any beneficial or other interest in the trust, including spouses.
  5. Written consent to the proposed transaction by the borrower on any existing mortgage or deed of trust (who probably made the transfer into the land trust) unless that party confirms in writing that the deed into the land trust was an absolute conveyance and that the grantor has no further interest in the property or in the trust.
  6. Possible lien of the real estate excise (transfer) tax and interest and penalties, if any, arising from the deed into the land trust or arising from any assignment of any beneficial interest under the trust. Also, for title insurance purposes, the land trust would need to be the grantor on the deed, and the deed would need to be signed by the trustee in its capacity as trustee under the trust agreement, similar to the following:

    _________________________________ BANK NATIONAL ASSOCIATION, not personally but as trustee under Trust Agreement dated ___________, 20_ _ and known as Trust Number
    ________________.
    By:
    _________________________________
    [Authorized Signature]

Advantages and Disadvantages of a Land Trust

A. Advantages of a Land Trust.

Land trusts are perceived by many to possess distinct advantages over other methods of ownership of real property. See, e.g., The Land Trust, Young Lawyers Network, probate & property, January/February 2007, at p. 6, which contains the following summary of the creation of a land trust and its advantages:

Often, trustee action is limited to the conveyance of the property when the trust terminates. Land trusts are unique because the duties and powers of the trustee are so limited, but it is still considered a trust and generally governed by the principles that are otherwise applicable to all other trusts.

The land trust is created through two documents—a deed into land trust and the trust agreement. The deed into land trust typically establishes the rights and responsibilities of the trustee. It usually states that the beneficiary’s interest is a personal property interest and that the beneficiary does not hold title of any kind to the real property. The land trust usually provides that the beneficial interest holders are able to direct the trustee in all matters of title and management of the real estate.

The land trust has attained its popularity and wide use because of the practical elements that the beneficial interest provides:

  • the interests of the beneficiaries will not be disclosed without order of court;
  • the interests are not subject to partition;
  • the beneficial interest is personal property and, therefore, avoids ancillary probate requirements;
  • transferability of beneficial interest is simple;
  • the beneficial interest can be used as collateral; and
  • testamentary dispositions can be set out within the trust agreement, thereby avoiding probate.

See also George Gleason Bogert, George Taylor Bogert, and Amy Morris Hess, the law of trusts and trustees § 249 (Trusts used primarily for business purposes—Trusts used in the purchase, operation and sale of real estate) (Rev. 2d ed. 2006), where the authors describe the benefits of land trusts as follows:

The advantages from the use of a land trust, particularly where there is to be multiple ownership of real estate, have been described by many writers. For example, record title in the trustee is not affected by the death or incapacity of a beneficiary. Conveyancing is simplified since the beneficiary’s interest is not subject to dower and personal judgments against the beneficiary do not become liens on the trust’s real estate. Financing is facilitated, either by the trustee obtaining mortgage loans secured solely by the trust property, or by the beneficiary pledging his beneficial interest treated as personal property, and both trustee and beneficiary can be exonerated from personal liability. Privacy of ownership is provided since the sole document recorded is the trust deed showing only the number of the confidential trust agreement in which the identities of the beneficiaries are disclosed. Where carefully drafted, the land trust will avoid the tax disadvantage of a corporation whereby both the corporation and the shareholders receiving distributions are subject to federal income tax.

In addition there are estate plan advantages to ownership of beneficial interests in real estate held in a land trust rather than the real estate itself. The beneficiary may dispose of his interest by a gift, sale or by testamentary disposition without affecting trust title to the real estate or causing termination of the trust or partition of the real estate.

B. Disadvantages of a Land Trust.

The use of land trusts in Illinois is not nearly as common as it once was, especially in commercial transactions (although they still are sometimes used in connection with tenancy-incommon transactions). Many people believe that a land trust protects them in some way, as beneficiaries, from disclosure or liability with respect to creditors, judgments, taxes, etc. This is generally not true (although judgments against beneficiaries do not create a lien against the real estate, which can facilitate the transfer of real estate). See, e.g., 765 ILCS 405/2, which requires that:

Whenever any trustee of a land trust, or any beneficiary or beneficiaries of a land trust, make application to the State of Illinois or to any of its agencies or political subdivisions for any benefit, authorization, license or permit, relating to the land which is the subject of such trust, any interest therein, improvements thereto, or use thereof, such application shall identify each beneficiary of such land trust by name and address and define his interest therein. Each beneficiary shall be identified, regardless of the size of the beneficiary’s interest in the land trust.

Land trusts also make a sometimes poor substitute for a will or living trust, since the trustee will insist on strict interpretation and construction of the provisions of the trust agreement before the property can be dealt with. Also, the trust rarely deals with the possible contingencies in the detail that a will or trust does.

Land trusts have some legitimate purposes, but not as many as most people believe. A land trust can be a convenient and inexpensive way to hold title and to convey title. It may sometimes be useful (subject to the caveats mentioned above) for individual estate planning and to hide the identity of developers assembling a development property bringing a number of parcels together. In Illinois, however, it does nothing to shield the real owners of the property—the beneficiaries of the trust—from tort liability. (It can shield them from contractual liability if the contracting party is sufficiently trusting or naive to accept a contract without personal guarantees or some other method to bring one or more of the beneficiaries into the deal—such as a sufficient monetary deposit.) But it generally won’t even protect the privacy of the beneficiaries should a new building collapse or an old building be charged with building violations; the litigation will go directly to the beneficiaries as the trustee will instantly disclose same should it be so ordered by a court (see discussion below). Also, ownership as a land trust says nothing about the operations of the trust, except that the trustee has a duty (its only real duty) to convey upon the instructions of those named in the trust agreement as holders of the power of direction.

An LLC, as noted earlier, may be the beneficiary of a land trust, with the managing director of the LLC, e.g., having the power of direction of the trust. And there may be good reason to adopt such a structure. But if the goal is to protect against tort liability, the “naked” land trust is clearly not the way to go.

Proper Party in Land Trust Litigation

In litigation involving a land trust, the issue often arises as to who is the proper party for liability purposes; the land trustee or the beneficiary(ies). This in turn will depend on the rights, duties and obligations set forth in the trust agreement, as well as the degree of control of the trust assets exercised by the land trustee or the beneficiaries. Generally, true ownership in a land trust lies with the beneficiaries even though title lies with the trustee. See, e.g., Wachta v. First Federal Savings and Loan Association of Waukegan, 103 Ill. App. 3d 174 (2d Dist. 1981), which typifies the judicial treatment of the land trust vehicle for litigation purposes. In this case, the court stated as follows:

The owner of the beneficial interest in a land trust is accorded four basic powers: (1) to possess, manage and physically control the real estate; (2) to receive all income generated by the property; (3) to direct the trustee in dealing with title to the real estate; and (4) to receive the proceeds of any sale of the property made pursuant to the power of direction.

That in turn leads to the means of determining the proper party litigant in a land trust situation (Just Pants v. Bank of Ravenswood, 136 Ill. App. 3d 543, 547, 483 N.E.2d 331, 335, 91 Ill. Dec. 49 [1st Dist. 1985] [citations omitted]):

In an action involving a land trust, the question of whether the beneficiary or the trustee is the proper party depends on the nature of the action in light of the rights and duties established by the trust agreement. ... The beneficiary in a land trust is the proper party to litigation involving his rights and liabilities of management, control, use, and possession of the property.

Id. at 176 (citations omitted).

If the property is intended to be sold and is owned by an Illinois land trust, the trust (i.e., the trustee), as exclusive holder of legal title to the real estate, would be a necessary party in an action for specific performance by the purchaser. The trust would also be a necessary party with respect to a foreclosure action against the subject property. See, e.g., 23-25 Building Partnership v. Testa Produce, Inc., 381 Ill. App.3d 751, 755 (2008) (“In a land trust in Illinois, the trustee’s sole purpose is to take and hold title to the trust res” (citation omitted) ... The beneficiary manages and exercises all rights of ownership, with the exception of holding title to the property”); Madden v. University Club of Evanston, 97 Ill. App.3d 330, 333 (1981) (holding that individual beneficiary of land trust lacked standing in mortgage foreclosure action against subject property because he did not have legal title to the property).

However, the trust and trustee will not have any personal liability and the trustee’s sole duty, if the purchaser prevails, would be to convey title to the property to the purchaser. But the beneficiaries, although holders of personal property interests and not title to the real estate, likely also would be added as parties to the action. As to whether land trust beneficiaries are necessary or proper parties in litigation matters involving property where legal title is held by a land trust, see Dept. of Conservation v. Franzen, supra, 43 Ill. App. 3d at 379 (“[u]ndeniably, the beneficiary of an Illinois land trust has a form of property interest. The beneficial interest, however, is not a direct interest in the real estate res of the trust”). If the purchaser prevails, the beneficiaries would have to direct the trustee to convey title to the property to the purchaser. With respect to the standing of land trust beneficiaries in a lawsuit see 23-25 Building Partnership v. Testa Produce, Inc., 381 Ill. App.3d 751, 755 (Ill. App. 1st Dist. 2008), where the court held that the beneficiary of a land trust had standing in litigation involving his rights and liabilities with respect to management and control, use, or possession of the property pursuant to the trust agreement.

DELAWARE BUSINESS TRUSTS

Delaware has had in effect since October 1, 1988, the Delaware Statutory Trust Act, 12 del. c. § 3801 et seq. (“DST Act”), which expressly recognizes the Delaware statutory trust (“DST”) as an alternative form of entity. A DST has been used in the place of a common law trust in many forms of structured financing transactions. The certainty of using an entity that is governed by statutory law rather than the common law is an obvious advantage. The principal purpose of the DST Act is to modernize the common law and provide certainty by codifying Delaware law with respect to the use of trusts in business transactions. A DST provides flexibility similar to a limited liability company (“LLC”), i.e., it permits the trust agreement to establish whatever rights and obligations of the trustees, the beneficial owners, and other persons as may be considered desirable (including voting rights). It also may provide rights to any other person, including a person who is not a party to the trust agreement. It further has advantages as a “bankruptcyremote entity.” The DST Act states that the statutory trust is a separate legal entity, and that no creditor of a beneficial owner has any right to obtain possession of, or otherwise exercise legal or equitable remedies with respect to, the property of the statutory trust. In addition, the DST Act states that no beneficial owner has any interest in specific statutory trust property and may not terminate or revoke the trust except in accordance with the trust agreement. Thus, creditors of and other interested persons in the DST have greater protection from the possibility of a partition of trust property or the premature termination of the DST upon the insolvency or bankruptcy of a beneficial owner than in the case of an ordinary common law trust.

A DST may merge or consolidate with, or convert into, any other corporation, limited partnership, or limited liability company pursuant to statutory procedures contained in the DST Act. There is no Delaware franchise tax on DSTs formed under the DST Act. The trust will be taxed for income tax purposes as a corporation, a partnership, or a trust or otherwise as elected by the parties in accordance with the Internal Revenue Code. The DST Act provides that at least one trustee must be a Delaware resident, although this requirement can be satisfied by engaging a trust company with its principal place of business in Delaware.

The following should be kept in mind by title insurers with respect to insuring DST transactions:

  1. The DST is treated as a separate and distinct legal entity, and unlike the situation with some other types of trusts, the DST would sign title documents in the following manner: XYZ Trust, a Delaware statutory trust, by ____________________, Trustee.
  2. If the governing instrument of a DST so provides, a “Manager” could be designated to execute documents on behalf of the DST.
  3. Every DST must have at least one trustee, i.e., a DST certificate of trust filed with the Secretary of State must state the name of the DST and the name and business address of at least one of the trustees.
  4. A DST is not required to execute its governing instrument. (A DST is bound by its governing instrument whether or not the statutory trust executes the governing instrument.)
  5. There may be, within the DST (as set forth in the governing instrument), separately designated series of trustees, beneficial owners, or beneficial interests having separate rights, powers, or duties with respect to specified property or obligations of the DST.

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