Beneficiary Agreement Considerations

Many, if not most of the beneficial owners of property held in Land Trusts have probably not entered into any formal agreements other than the bare land trust agreement. As long as there is only one beneficiary, or a small number who are closely related and agree on everything, this will suffice. This arrangement however, is similar to the unwritten partnership. Absent a written partnership agreement, when the partners begin to disagree, they must rely on rules of law and the courts to determine their legal rights.

In many situations, the law does not provide remedies the parties would have selected if they had decided among themselves how to deal with conflicting situations. Where there are multiple beneficiaries, no matter how closely related, the absence of a definite operating agreement amongst the beneficiaries exposes the trust agreement to a variety of problems. A close examination of the trust instrument will disclose that each beneficiary has a right to manage the property and to collect the rents, and no specific obligations are imposed to perform the many functions incidental to the operation of the property. In addition, the trust agreement does not provide for resolution of divergent views relating to the operation, financing, sale, or other disposition or encumbrance of the land trust property.

A. Partnership Aspect.

1. In most states, the Revised Uniform Partnership Act provides that a "partnership" is an association of two or more persons to carry on a business for profit as co-owners (See Fla. Stat. §620.8101(5)). Thus, unless the parties agree otherwise, in writing, the relationship between individuals acquiring real property "to carry on a business for profit" will be governed by the Revised Uniform Partnership Act. However, because the Revised Uniform Partnership Act superseded all the common law of partnerships and joint ventures, there is a possibility that the common law of a jurisdiction regarding the relationship between "joint venturers" may control. A properly drawn partnership or joint venture agreement among the beneficiaries will contractually establish the relationship among the beneficiaries.

B. Elements of the Agreement.

What should be accomplished by a beneficiary agreement and how can it provide for the parties' choice of the form of agreement among themselves rather than relying on the common law of co-owners, partnerships, or joint venturers?

1. Income Tax Consequences: First and foremost are the income tax consequences of the ownership of income producing property by two or more beneficiaries. Having a detailed trust agreement in the nature of a partnership agreement (or having a partnership or joint venture hold the beneficial interest in a Florida Land Trust as partnership property or joint venture property, pursuant to a written partnership agreement) should assist in establishing taxation as a partnership rather than as a corporation. Without careful drafting and consideration of the relationship between the beneficiaries there is a very real possibility of the land trust being taxes as a corporation rather than as a partnership.

Further, use of a partnership to hold the beneficial interest in the land trust pursuant to a partnership agreement can give the beneficiaries the use of special allocations and other tax advantages often found in partnerships. Note, however, that if the beneficiaries will not actively participate in the management of the property because they designate a "managing partner" or the circumstances preclude them from participating in management (an orange grove in Florida can't be operated by investors in Ohio), there may be a need for compliance with federal securities laws and state "blue sky" laws, and a limited partnership limiting the liability of passive beneficiaries would be the preferred entity.

2. Management: Additional benefits can be obtained from a properly drawn beneficiary agreement because the trustee will have no obligation to manage the trust property; he is merely a conduit for rents, profits, income, etc. generated by the trust property. The trust beneficiaries may not want all of their membership to have equal privileges in the management of the trust property and may wish to delegate management responsibilities to one or more of the beneficiaries. A properly drafted agreement can clearly establish the rights and responsibilities of the managing beneficiary(ies) among the group of beneficial owners. This would be especially important in a land trust that has many beneficial owners holding freely transferable certificates evidencing their beneficial ownership; the beneficial ownerships will be more freely transferable if the purchaser of a beneficial interest knew that the property is being managed by a professional, either as a beneficiary under the land trust or as an outside manager hired by the beneficiaries.

Again, note that a limited partnership holding the beneficial interest in the land trust may be the preferred investment vehicle.

3. Record Maintenance: Under federal income tax laws, it is necessary that proper records be kept for the income and expenses of all properties held in the land trust. An agreement specifying that books of account be maintained and that payment for accounting services be made from the income of the property assures that the trust's records will be properly kept for income tax purposes.

4. Contributions: One of the most common problems occurring in connection with the ownership of property by several persons involves the co-owner who fails to pay his share of necessary expenses. The co-owners who pay their expenses, of course, have a right of contribution against the defaulting co-owner. They are entitled to an equitable lien on the premises for the amount of such payments. However, in order to enforce either of these remedies, the co-owners paying the expenses must establish that the expenses were necessary for the preservation or use of the property. No co-owner has the right to make permanent improvements without the consent of the other co-owners. If he does so without such consent, he has no right of contribution against the other co-owners and can collect for his improvements only upon the sale of the premises and a showing that the price received upon the sale was increased by the value of the improvements. He will have the right to receive the income that can be ascribed to the improvements. He will have no right, until final disposition of the property, to a contribution from the others for their actual cost.

The entire area of additional cash contributions for improvements to the trust property is a special breeding ground for disputes among beneficiaries and the partners. In addition, the area of payment for repairs and improvements of the trust property should be considered by the beneficiaries and provisions should be made in the agreement to reflect their desires rather than relying on the Florida Revised Uniform Partnership Act or the common law. For example, the agreement could provide that repairs up to a certain cost amount be made unilaterally by the managing partner, if any, or by the building manager, and improvements or repairs above that amount must be agreed upon by all, or at least the majority, of the beneficiaries.

5. Remedies of Co-Owners: By a properly drawn beneficiary agreement much more pressure can be brought to bear upon a defaulting co-owner. The agreement should specify that a defaulting co-owner can be sued for amounts due from him, and it should also indicate that the amount due from him is collectible from any income due to him out of the proceeds of any sale or cash flow from the trust property. One of the most common procedures used to handle a defaulting, or unhappy partner, is the "buy-sell" provision found in among all partnership agreements. This provision would require that a written demand for compliance with the agreement be made on the defaulting co-owner and in the event of non-compliance for a specific period, the non-compliance would be treated as an offer by him to sell his interest in the property at the then book value. Since book value would normally be substantially less than fair market value, a defaulting co-owner would be strongly motivated to come up with his share of necessary expenses. Other penalty provisions may also be used, such as a forfeiture of all income or benefits until the default is cured.

6. Right to possession: In the absence of a beneficiary agreement, any co-owner has the right to possess, share and use the property until such time as the other co-owners assert their rights. If such a co-owner takes possession of the property and, for example, raises crops himself, the other co-owner who stood by permitting him to do this has no right to any of the proceeds. The co-owner not in possession may demand that the other co-owners pay him rent for use of the property, and the occupying co-owner will be liable for a fair rent. A properly drawn agreement will provide for possession of the property and rents and/or incomes to be charged and distributed among the beneficiaries, thus no co-owner can profit from the neglect of any other co-owner to act.

7. Mortgage obligations: In the absence of very special circumstances, the beneficiaries of a land trust will have no personal liability for the payment of a mortgage debt or performance of any other obligations under a mortgage. Lawyers Title Guaranty Fund v. Koch, 397 So.2d 455 (4th DCA 1981). A beneficiary agreement providing that each of the co-owners shall be liable for the proportionate share of all expenses, could eliminate this exculpation from personal liability, making the co-owners personally liable for mortgage payments. Conversely, a clause could be included in the beneficiary agreement to eliminate the possibility that personal liability will be created where there was no personal liability in the actual agreement between the trustee and the mortgagee.

8. Transfer or Sale of Beneficial Interest: One of the important advantages of the land trust form is the free transferability of the beneficial interest. Any beneficiary may assign his interest in the trust property to anyone he chooses and the other beneficiaries must accept this person as a co-owner. Since most people like to select their partners, if the beneficiaries want to prevent someone else from coming into ownership, a properly drawn beneficiary agreement will provide for the right of the remaining beneficiaries to control the selection of any new members to the land trust. This is handled by the "buy-sell" provision; the group of beneficiaries maintains the right of first refusal on any sale of a beneficial interest. Sample "tag along" and "drag-along" provisions are attached as Appendix F. Please note that these are sample provisions only and must be tailored to fit the terms and conditions of each situation.

Beneficiary agreements often provide that if a beneficiary wishes to sell his interest, he must offer his beneficiary interest to the remaining beneficiaries at its then book value (cost less depreciation). This is based upon the belief that the remaining beneficiaries should not have to buy out the beneficiary wishing to leave the partnership at an appreciated value when the selling beneficiary does not want to continue in the group. This, of course, very much limits free transferability of beneficial interests and prevents a beneficiary from realizing the appreciation of his investment. This procedure is probably best used in the situation where the remaining beneficiaries are "bailing out" a beneficiary who cannot meet a cash call for additional partnership expenses. A more common "buy-sell" provision would allow any beneficiary to offer his interest for sale to the group of beneficiaries at an agreed upon price, usually determined by appraisal, and the group would be required to purchase the interest at the agreed price.

9. Death or Incompetency: Death or incompetency, however, are not within the control of the beneficiary, and in such an event it is desirable to have an appraisal made to make sure the estate of the deceased or the incompetent will get the fair market value for the beneficial interest. Of course, the purchase agreement should be flexible and not mandatory, and the remaining beneficiaries should have the right to decide whether or not they want to buy and should not be forced into it.

10. General Considerations: Depending on the type of property involved, the complexity of the operation and management of the property, and the number of beneficiaries, there are many matters that can be included in a properly drawn beneficiary agreement. The matter of selecting a building manager or one of the co-owners to manage and operate the property can be clearly set forth in the agreement. Interest rates on loans from or to co-owners can be established as well as the matter of selecting accountants, lawyers, and other professionals who may assist in the operation of the property. If the beneficial interest is held by a partnership, a method of accounting to be used can be stated and a fiscal year can be established. Special provisions can be drafted to deal with the authority to make improvements and repairs. The authority to make leases, mortgages, and deeds of property should be spelled out. This is most important when giving directions to the trustee to make leases, mortgages and deeds since the trustee will want it clearly established from whom he will be required to take written direction to take these actions.