Friendly Liens to Hide Equity

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In looking for something to write about in the BiggerPockets forum I came across a thread dealing with “friendly liens” for asset protection.  If you are not familiar with the term, a friendly lien is simply a lien against property you own by a party that is friendly to you.   The friendly party is typically a corporation or LLC you have created in a jurisdiction like Nevada or Wyoming, which allows the use of a nominee to mask the your involvement with the business entity.  Friendly liens are considered effective asset protection tools because a potential predator i.e., creditor, that comes along after the friendly lien is in place, may consider the property unworthy of pursing because of its lack of equity.  The friendly lien essentially “encumbers” a property–it ties it up, and makes it look less attractive.

For predatory lawyers, any lawsuit is a numbers game.  The decision to pursue litigation or collections is an economic decision. If the economics are not beneficial, because the property appears fully encumbered, the creditor may not pursue the case, or will certainly accept less.  Thus, the friendly lien is designed to make you appear worthless to outsiders looking in.  However, the manner in which you structure this transaction can have beneficial or detrimental consequences.

Friendly Liens Gone Bad
By running a simple Google search for “offering false instrument for recording” or “counterfeit lien” you will receive a number of hits for state statutes that list this as a criminal offense. (In the civil context filing a false lien is referred to as “slander of title” and will result in substantial fines.)  Does this imply that to engage in the strategy mentioned above you will face criminal prosecution?  Depends on who you lien and how you put it together.

• If you file a false lien against a public official as in the case of Mr. Hoodenpyle of Denver, best get out your best orange jumpsuit because you will be wearing it for one to three years.  (Mr. Hoodenpyle was convicted for filing a lien against the property owned by an IRS revenue officer after the IRS had filed liens against Hoodenpyle’s property.  The false lien indicated that the IRS officer owed Hoodenypyle more than one million dollars.)
• If you file a friendly lien with the intent to defraud the IRS, you will bunk with Bubba.  Take a look at United States of America vs. William S. Reed.  In this case, Mr. Reed was alleged to have assisted individuals in filing friendly liens against their property to prevent the IRS from levying liens against the taxpayers real estate.  Uncle Sam is going to get his due and any moves made to hinder, delay, or defraud will not end well for the taxpayer.
• If you file a friendly lien that lacks economic substance you may run afoul of these statutes, however this is not so clear.  It would appear from a careful reading of the statutes the lien must be accurate.  In other words you cannot imply that your LLC loaned you one million dollars when in fact it never did.  I was unable to find a case wherein a person was prosecuted for filing a lien against his own property, but that should not imply one does not exist.

Friendly Liens That Might Work
If you are interested in pursing this strategy and you are not doing it for the reasons mentioned above, then consider the following:

• The lien should be accurate and reflect the substance of the transaction.  For example, if you have created a LLC and it is going to record a friendly lien against your real estate, the lien should be structured as an Equity Line of Credit and not a loan.  In an ELOC transaction the lending party is agreeing to loan the borrower a set sum of money upon demand by the borrower.  In the residential context you will know this as a HELOC;
• Your LLC or other entity should have some available cash or investments to actually make the loan; and
• In addition to recording the lien you should draft a promissory note between yourself and your LLC that contains commercially reasonable terms.

A friendly lien is a smoke screen strategy.  It will not protect you if a creditor decides to initiate collections.  If challenged, the lien would be ignored to the extent you have not borrowed funds from your LLC.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.